Graeme Hancock
Oil Gas and Mining Policy Department (COCPO)
The World Bank
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• Grade = concentration of valuable mineral element within a rock mass. e.g. 1g/t Au or 0.5% Cu
• Ore = rock which is economically viable to mine, where the value of the metal exceeds the costs of mining, processing, (crush, extract and purify) and marketing the commodity
• Waste = rock where the grade is insufficient to cover the costs of processing and marketing
• Cut-off grade (or breakeven grade) = The grade or concentration of mineral in rock where the value of the metal equals the costs of mining, processing and marketing the contained commodity
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• Minerals are fundamental to sustainable development and maintenance of a “developed” lifestyle – every commodity we use is either grown or mined or synthesized from products that are either grown or mined
• Take a moment to examine that statement – If you drove to work, you did so in a pile of minerals fueled by petroleum (liquid minerals) - or perhaps by metro – a pile of minerals powered by coal and uranium (for electricity generation).
• The mineral resources of the earth are virtually limitless, what constitutes ore is a function of commodity price, technology, extraction cost and government policy
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• Most people are of the misconception that when you go to a gold mine you dig gold or at a copper mine you dig copper. –
–
• At both mines you dig rock – of which a tiny fraction will be gold or copper
• Open cut gold mines these days average 1-3 grams of gold per tonne of rock (i.e 1-3 ppm)
• Open cut copper mines average 0.5 - 0.6% copper (or 5 - 6kg of copper per tonne of rock)
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1
3
5
4
2

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Tonnes vs Grade
1000
900
800
700
600
500
400
300
200
At 0.2% Cu cutoff grade
Mineable resource = 1000Mt
Average grade = 0.5% Cu
Total tonnes of saleable copper = 5.0Mt
At 0.4% Cu cutoff grade
Mineable resource = 500Mt
Average grade = 0.7% Cu
Total tonnes of saleable copper = 3.5Mt
100
0
0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0% 2.2%

Tonnes vs Grade
1000
900
800
What Factors Contribute to Lowered Cutoff Grades
700
600
500
400
300
200
Increase in commodity prices
Improvements in Mining or Processing Technology
Reduction in unit operating costs
Reduction in taxes on inputs e.g. royalties duties etc
Results in:
Longer mine life
Greater utilization of resources
Higher overall value of production
100
0
0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 1.2% 1.4% 1.6% 1.8% 2.0% 2.2%

• In 1972 Meadows and the Club of Rome declared that by the year 2000 the world would have exhausted all reserves of copper
• And yet today we have more undeveloped copper resources in the ground than at any point in our collective history
• Meadows failed to recognize that changes in commodity prices and advances in technology turn waste into ore!
• However, royalties and input taxes turn ore into waste
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Key Issues in Designing a Mining Tax System
What is Unique about the Mining Sector?
• Large diversity of mineral types (sand, dimension stone, coal, base metals, gold, diamonds)
• Diversity of scales of operations (from very small to very large scale)
•
Significant exploration expenditures and risk will precede startup of mining, exploration expenses will occur long before taxable income is available or even a decision to mine
•
Mine development is often hugely capital intensive
•
Capital is captive – you cannot move the mineral deposit
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Key Issues in Designing a Mining Tax System
What is Unique about the Mining Sector?
• Mines will initially import most of their specialized capital equipment
•
Most mineral products compete in an open market where they are price takers
•
Different minerals have very different labor, cost, price, and environmental and social impacts
•
When mining ceases there is no income to deal with mine closure and environmental costs
•
Mines may have either long or short lives
•
Minerals are usually the property of the State
•
Commodity prices are often highly cyclical
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Recent Trends Western World
Constant June 2002 US$ Million
$5000
Rest of World
$4000
SE Asia / Pacific
$3000 Latin America
Africa
$2000
USA
$1000
Canada
$0 Australia
1970 1975 1980 1985 1990 1995 2000 2005
Sources : WMC, MacKenzie & Metals Economic Group
From Otto 2006
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Global exploration expenditure:
• 1997: US$5.2 billion
• 1998: US$3.7 billion
Many Countries lowered taxes
• 1999: US$2.8 billion
• 2000: US$2.6 billion in the period 1997-2002 to attract new investment
• 2001: US$2.2 billion
• 2002: US$1.9 billion
• 2003: US$2.4 billion
• 2004: US$3.8 billion
• 2005: US$5.1 billion
Temptation to raise taxes or in some cases to nationalize often due to regressive tax systems and politicians feeling that the country is not getting a
“fair” share
Source MEG and Otto
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Key Issues in Designing a Mining Tax System
Dealing with Cyclicity
When prices are high:
Surpluses are available to be taxed
Special taxes may be levied: e.g. additional profit tax, graduated (sliding scale) royalty
When prices are low:
Without relief from input or revenue based taxes, mines may become loss making and close
This can result in both short and long term fiscal reductions
Possible Approach: loss carry forward, discretionary relief from royalty
Optimally you design a tax systems which can cope with
Both the ups and downs of commodity cycles
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Key Issues in Designing a Mining Tax System
Why Fiscal Stabilization – Investor Risk Mitigation
•
Company perspective:
– Need to provide assurance to lenders that cash-flow will be sufficient to meet repayments
– Reduces risk that a mine may be subject to increased taxes
(moving the goal posts) once the capital is captive but before payback is achieved
• Government perspective:
– Administrative challenge: different mines will have different tax systems
– Should we bind the hands of future lawmakers?
– Should a risk-premium be paid? ( e.g. Peru, PNG, Chile)
– How long? For the financing period? 10 years? Life of mine?
– Which mines (all, or only large mines)?
– Which taxes?
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Key Issues in Designing a Mining Tax System
How to Influence taxpayer behavior: some examples
Encourage value added processing:
• High royalties on ore, lower royalties on concentrates, lowest royalties on metal
• “free trade zones” & “special industrial zones” that provide reduced tax regime
Encourage exploration:
• Double deductions for exploration costs (Argentina, PNG)
Encourage R & D:
• Tax credit for approved research to improve mineral processing
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Almost all Governments choose to have some specific provisions for Mining and some Governments have entirely separate mining fiscal codes
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Key Issues in Designing a Mining Tax System
Characteristics of a good mineral tax system:
From the Investor’s viewpoint
Tax system should :
• maximize the net present value of the company’s revenue
• be based on realized profitability
• permit early pay-back of capital
• recognize the volatility of markets
• be stable and predictable
• transparent
• avoid tax types that distort extraction profiles
• avoid tax types that penalize increased efficiency
• encourage investment in exploration
• encourage investment in marginal mines
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Key Issues in Designing a Mining Tax System
Characteristics of a good mineral tax system:
The Government’s view
Tax system should :
• maximize the value of tax revenue
• support macroeconomic stability by providing predictable and stable tax revenues
• capture more revenues during periods of high profits
• capture more economic rent from extraordinarily low cost, or high grade mines
• be effective with low-cost administration
• not be vulnerable to tax avoidance
• encourage exploration and expansion of the tax base
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• Usually applied:
• income tax (25 to 35% )
• withholding tax on dividends, loan interest and services
(10 to 20% )
• royalty (2-4% )
• land use fees (per square unit area, low)
• administrative fees and transaction charges ( low )
•
Rarely applied:
• Additional profits taxes RRT (very rare )
• import and export duties (zero rated or exempt )
• VAT (refunded, offset or zero rated )
• free equity dividends ( indirect taxation )
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• Common Incentives
• accelerated depreciation
• loss carry forward
• no ring fencing rules
• carry forward and amortization of exploration, feasibility, development costs
• deductible environmental and closure costs
• deductible community and public infrastructure costs
• Less common incentives
• fiscal stabilization
• tax holiday or initially reduced rates
• Depletion allowances
• loss carry back
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Typical Components in a Modern Mining Tax System
• Income tax
• Dividend withholding tax
• Royalties (ad valorem)
• Import duty on equipment
• Export duty on minerals
• VAT
• Depreciation
• Depletion
• Ring fencing
• Exploration
• Environmental costs
• Closure costs
• Tax holidays
• Loss carry forward
30%
15%
2-5% none negated none accelerated & pooled none none amortized (5 yr) expensed deductible closure fund none
7 year or unlimited
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• In analyzing mining tax systems, it is essential to look at the complete system of all taxes and fees rather than at individual rates in isolation
• Need to establish the total effective tax rate (ETR) which will be imposed on a mine
• The best way to do this is to use a standardized mine model and apply all applicable taxes for each country in that one model and compare the outcomes – this has been done by Prof James Otto and the Colorado School of Mines
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Comparative Analysis of Tax Systems
Effective Tax Rate: the combined impact of all taxes value of all amounts paid to government
E ffective T ax R ate = -------------------------------------------------value of profits before taxes are paid
But the ETR is not the complete story, because the ETR does not tell you anything about the timing of tax payments
Note in the following slide that although Chile and Western
Australia have the same ETR they have significantly different investor rates of return – because WA does not offer accelerated
Depreciation whereas Chile does
Note also that in Fiji a 3% royalty increases the ETR by 6.5%
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Country
Sweden
W. Australia
Chile
Fiji (no royalty)
Zimbabwe
Argentina
China
Fiji (2% royalty)
PNG
Bolivia
Fiji (3% Royalty)
South Africa
Philippines
Indonesia (7 t h , COW)
Kazakhstan
Investor’s Internal Rate of Return (%)
Effective Tax Rate
(%)
Lowest taxing quartile
15.7
12.7
15.0
14.5
13.5
13.9
12.7
13.6
Second lowest taxing quartile
13.3
11.4
13.2
13.5
13.5
12.5
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12.9
28.6
36.4
36.6
37.6
39.8
40.0
41.7
42.0
42.7
43.1
44.1
45.0
45.3
46.1
46.1

Model Copper Mine: Comparative Effective Tax Rates
Sw eden
Western Australia
Chile
Zimbabw e
Argentina
China
P.N. Guinea
Bolivia
South Africa
Philippines
Kazakstan
Indonesia
Peru
Tanzania
Poland
Mexico
USA (Arizona)
Greenland
Guinea
Ghana
Mongolia
Ivory Coast
Uzbekistan
0
From Otto 2006
Ideal range ?
ETR = 40 to 50%
10 20 30 40 50 60 70
Effective Tax Rate - %
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80 90 100 110

Division of Mine Revenues
A Typical Medium Sized Copper Mine
(50% Effective Tax Rate)
New exploration
New mines
Dividends
Profits
17%
Banks
Loan Costs
2%
Operating
Costs
44%
Wages
Consumables
Spares
Power
Water
Community?
National?
Provincial?
Local?
Taxes &
Fees
17%
From Otto 2006
Capital
Costs
21%
Contractors
Suppliers
Infrastructure
Others
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Conclusions
• Countries compete for mineral sector investment and generally offer terms of ETR between 40 and 50%
• Investment will flow to where the geology is attractive, the regulatory systems are workable, and taxation is reasonable and predictable
• Tax systems are converging, there is a need for countries to be competitive without sacrificing too much revenue – provide incentives for exploration and increasing the NPV of investor without changing the ETR
• Tax systems should be responsive to periods of low and high prices – many are currently slightly regressive
• Well designed tax systems can provide a fair contribution to the treasury whilst still promoting new investment
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Don’t expect mines to carry too heavy a tax burden
Can it carry one more input tax and still remain viable?
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