By Grain Wyson Phillip Malunga FIMMM Minerals, Geology, Environment & Corporate Affairs Consultant
Fiscal Regime and The Mining Sector Raw Deal
Fiscal regimes need to be designed in such a way as to create smart partnership between government and the resource companies. While governments try to maximize revenue from the minerals industry, they also need to let companies realise return on their investments. Building trust between the two partners increases investor confidence.
The paper explores how fiscal components and tax justice can affect government revenue.
It is universally accepted that natural resources are a nation’s inheritance and belong to its people. Mining companies come into the country to exploit these resources with full understanding that there will be benefit sharing between government and the company. This benefit sharing is guided by the fiscal regime of the host nation. Governments try to use fiscal regime tools to maximise their revenue while mining companies look for loop holes to maximise revenue for its shareholders. An effective fiscal regime maximises government revenue while maintaining a good return on investment for resource companies.
The paper tries to enlighten policy makers and “watch dogs” on how the fiscal regime of natural resources projects can be designed to realise a fair share of the profits for government and resource companies.
Governments collect the following from resource companies:
- Annual ground rent per hectare – Other countries allow payments to local Administrative authorities. In Malawi, Exploration Licences pay MK1,000 per hectare while Mining Licences pay MK10,000 per hectare.
- Royalties – These are a percentage of the value of minerals produced without taking into account production costs. Royalties vary normally between 5 and 10 %.
- Corporate Income Tax – This is a percentage of net profit (after deducting operation costs). Corporate Tax may range from 30 to 35%.
- Withholding Tax – This is a percentage of payments made to third parties. This can be in form of payment for services and dividends. In Malawi it is 10%-20%.
- State equity participation – This offers a share of profits to government as long as no operational risks are attached.
- Production sharing – This is mainly practiced in oil and gas projects. Companies collect an agreed share of produced oil to offset exploration and development costs. The rest is shared between government and the resource company. The initial oil produced is subject a royalty charge.
The design of a fiscal regime depends on how government wants to balance between attracting Foreign Direct Investment and maximising Effective Tax Rate (or its fair share of proceeds). Average Effective Tax rate for oil and gas varies between 50% and 80% while that of solid minerals varies from 40% to 70%.
Raw deals emerge when government designs regressive tools that offer lesser shares of the proceeds as profits increase. Some investment incentives are self-defeating in areas where companies take advantages of governments’ investment incentives. For example, Double Taxation Agreements encourage Transfer Pricing and Treaty Shopping. Lack of project ring fencing erodes government revenue collection as taxes are assessed together as one project in two projects with one that is highly profitable and the other loss making. Thin capitalisation reduces project revenue thereby prolonging non-payment of profit based taxes due to high and long loan servicing. Taxes that are affected in this situation include Corporate Tax and Resource Rent.
Policy makers need to monitor effectiveness of their fiscal regime. Fiscal regimes should maximise government revenue within shortest time possible.
Most governments rush to take state equity without proper mechanisms for monitoring their investment and putting up mechanisms for effective participation in the operations of the resource company. Lack of participation in working with the resource company leads to unethical activities such as transfer pricing on managing of procurement of goods and services.
Raw deals emanate from tax avoidance and tax evasion. Tax avoidance is the ability to reduce one’s tax burden while complying with tax law. Tax evasion corresponds with not reporting all of one’s income. Treaty shopping leads to tax avoidance and this is not illegal. Tax evasion is illegal as it is tantamount to cheating.
This happens due to some of the following reasons:
- Low ability of tax administration and fiscal courts to enforce tax liabilities
- Unwilling to pay due attitude of tax collectors
- High costs to prepare revenue accounts in order to comply with tax laws
- Bartering of goods
Any business ventures need to be properly monitored in terms of how they manage procurement of goods and services. Government needs to have a highly trained and sophisticated unit to maximise revenue from business entities without creating enmity with companies.
Fiscal regime design and management should bring investor confidence while maximising government revenue. Tax avoidance and evasion can be minimised in an environment of trust and respect for business operations. Insufficiencies in tax collection can be reduced through building capacity for tax collectors, motivating them and reducing compliance costs for resource companies.
– Deutsche Gesellschaft fur Internationale Zusammenarbeit (GIZ) GmbH. 2010. Addressing tax evasion and tax avoidance in developing countries.
– Malunga G. W. P. 2013. Fiscal Regime and Management of Revenue from Mining. Geomine Services
– Natural Resource Governance Institute. 2015. Fiscal Regime Design: What Revenues the Government Will be Entitled to Collect.
– PricewaterhouseCoopers. 2012. Corporate Income Taxes Mining Royalties and Other Mining Taxes: A summary of rates and rules in selected countries (2012), http://www. pwc.com/en_GX/gx/energy-tilities-mining/publications/pdf/pwc-gx-mining-taxes-and-royalties.pdf.
This piece was initially published in Malawi’s Mining & Trade Review Issue Number 62 (June 2018).