The piece “Updates on Malawi’s mining fiscal regime” featured below was initially published in Malawi’s Mining & Trade Review Issue Number 36 that is circulating this April 2016.

The full edition is available for download here. This monthly publication is edited by Marcel Chimwala.

Updates on Malawi’s mining fiscal regime

By a Correspondent

A lot has been said by different stakeholders about the country’s fiscal regime or the taxation package for the mining sector. Although the fiscal regime has undergone review and is awaiting enactment in Parliament, there are fears by the country’s citizens that the nation may end up losing out on its mineral endowments due to a weak fiscal regime. At the same time, there have been fears by the mining investors that the fiscal regime may be unfavourable and overly distortionary which would discourage investment into the mining sector.

As part of the process of addressing the fears by the different stakeholders, the Ministry of Finance, Economic Planning and Development, represented by one of its Extractive Industry and Energy Economists, Fredrick Maliro, gave a presentation on the proposed mining fiscal regime at the Alternative Mining Indaba that recently took place at Bingu International Conference Centre (BICC) in Lilongwe.

Maliro explained that the objective of the review was for Malawi to complete a coherent and standardized fiscal regime that is regionally competitive.

In other words, the mining fiscal regime is expected to achieve a balance between maximizing the national benefit, whilst at the same time attracting considerable investment into the mining sector taking into account the country’s geology and other industry factors. This search for balance is believed to have addressed the fears raised by different stakeholders.

The Economist, from the Ministry of Finance, Economic Planning and Development, took time to explain that the scope of the review, conducted between 2014 and 2015, was to (i) assess the headline rates of all fiscal instruments (such as the Royalty rates, Corporate Tax rates and Resource Rent Tax rates), (ii) strengthen the integrity measures of the fiscal regime and (iii) address perceived investment impediments, amongst others. He specifically pointed out that the country will maintain the same rates of fiscal instruments that are currently obtainable in the laws because they are regionally competitive. This means that the Royalty, Corporate Tax and Resource Rent Tax rates will remain the same as in Malawi’s current legislation but with new formulae for calculation.

Proposed Royalty Rates

However, the Economist highlighted that the legal provisions and the administration for the mineral royalty will now shift to the Taxation Act implemented by the Malawi Revenue Authority (MRA).

This means that the mining legislation will no longer prescribe the royalty rates as is currently the case, and, therefore, it will no longer be the Department of Mines that collects and enforces royalty payments.

The Government believes that the shift in royalty provisions and administration to the Taxation Act and MRA will not only help to simplify the system, but it is also expected that the Authority’s robust experience in tax assessment, audits and compliance enforcement will help to improve the collection of mineral royalty revenues, which has been a challenge for the Department of Mines due to inadequate resources for enforcement measures.

Whilst the royalty rates remain unchanged, the royalty calculation formula has been improved from the currently gross sales less transport and handling related costs to a commercial value basis,

said the Economist.

He shared with the participants of the Alternative Mining Indaba that a commercial value of a mineral is equal to the reference price for that mineral or other similar minerals obtainable in a competitive market times for the mineral content.

Maliro added that,

Where there is no reference price for a mineral in the state at which it is disposed of, its commercial value will be arrived at using ‘netback value’ and ‘cost plus value’ methods.

According to him, this approach is intended to maximize the mineral value, which forms the base for royalty rate application, and in turn, the royalty revenues collected by the Government.

Proposed Resource Rent Tax

According to Maliro’s presentation, the Government has also improved the Resource Rent Tax structure by introducing a calculation method of the resource rent based on after-tax cash flows.

Resource Rent is an economic term defined as the difference between the value of a mineral and the cost of extracting it from the ground and bringing it to the market plus a reasonable return to reward the risk taking behaviour of an investor.

Theoretically, it can be argued that the investor does not need the resource rent in order to make investment decisions. In other words, the resource rent is like a bonanza you do not need to either encourage or discourage investment.

For example, if Mining Company X needs to make MWK 100 per year to cover all their costs and to make enough profit to re-invest or share with shareholders, and it earns MWK 120 in that year, then the difference – MWK 20 – is what would crudely constitute the resource ent- whether or not the company receive this difference, it will still decide to start and continue mining because all its costs and a reasonable return to risk have been met. In that case, it could be argued that the Government could tax it all away without affecting investment decisions.

However, since it is difficult to determine the risk appetite of each and every investor for the purposes of calculating their expected return to reward risk, in practice, governments just impose a sizeable Resource Rent Tax rate to capture part of the resource rent without scaring away investors. In Malawi, the RRT rate is currently at 10% of after-tax resource rent.

Further features of the proposed Fiscal Regime

Maliro explained some other features of the proposed fiscal regime. The law will now allow for mining exploration companies to be able to register for VAT as an investment incentive, since they will be able to claim VAT before they begin to make taxable supplies as current VAT law demands. Currently, exploration companies incur input VAT, but because they are not yet making a taxable supply, they cannot claim back their input VAT. The implication of this is that the VAT ends up increasing the investment costs, and in turn, it makes the country uncompetitive.

In addition, the new mining fiscal regime has proposed improvements to the depreciation package in order to address a challenge that arose out of having an immediate expensing provision and a loss carry forward limit of six years.

What this means, in the current scenario, is that when a mining company invests into capital during the construction phase (which requires huge investment amounts), it will be allowed to deduct the whole capital expenditure from its taxable income.

Since the capital expenditure is so huge and the production volumes are still not very high in the early years of mining, the mining company will end up in a loss position after deductions for taxable income calculations. In that case, the company will be allowed to carry forward the losses to offset against future taxable income.

With the nature of the mining industry, it is unlikely that by six years, the mining company shall be able to recover all its capital costs, which means that it will lose the remaining unrecovered losses in as far as the current tax laws are concerned. Thus, the current depreciation package imposes an impediment on investment because there is a high chance that mining companies will lose out their legitimate costs.

The revised depreciation package addresses this challenge by treating capital expenditure in different categories and subjecting them to different depreciation provisions that both allow the investor to recover their costs eventually and relatively quickly, whilst at the same time hedging against revenue losses.

Finally, Maliro explained that to ensure that the integrity of the system is strengthened, mining projects will now be ring fenced – meaning that each mining project will be treated separately as a taxable entity regardless of whether or not the owner has other mining projects.

This will prevent the transfer of losses from one project to another that is profitable, which in the end will reduce taxable income. Similarly, there will now be a thin capitalization rule (a debt-equity ratio) aimed at limiting the amount of debt a mining company may hold for tax purposes.

The transfer pricing provision in the law has also been improved to address loopholes. This measure is across all sectors and not just the mining industry. Improving legislation in this regard will help to reduce the illicit financial flows that reduce the potential revenue the Government could collect.

The mining fiscal regime is expected to be tabled  together with the Mines and Mineral Bill in Parliament during the 2016/2017 budget sitting in June 2016

In case of any questions or need for clarifications, please contact Fredrick Maliro at [email protected].