CONCERNS ON THE PROPOSED 2009 MINING TAX REGIME
4th March 2009
This paper looks at the negative effects which may arise from the mining regime changes proposed to Parliament by the Minister of Finance and National Planning, Honourable Dr. Situmbeko Musokotwane, MP during the Budget Speech on 30th[1]
Among the most significant changes to the mining tax regime proposed in the Budget Speech are removal of the windfall tax, 100% capital allowance, and including hedging gains and losses in the mining revenues.
Civil society organisations, organized under Zambia’s newly founded chapter of the global Publish What You Pay (PWYP) campaign,[2] are concerned that the proposed mining tax revision could have calamitous consequences for Zambian development. Specifically, these changes could deprive the country of resources needed to invest in infrastructure, education, health, and other critical sectors. Therefore, PWYP respectfully rejects these proposed changes. In an effort to partner with the Government to secure a mining tax regime that supports people-centred development, PWYP has produced this policy brief to outline the downfalls of the Ministry of Finance’s proposed newly proposed mining tax changes.
This policy brief is divided into four (4) main components, namely:
- Introduction
- Discussion of Proposed Tax Changes
(a) Removal of the Windfall Tax
(b) Allowance for Hedging Gains and Losses in Mining Revenues
(c) Increased Capital Allowance
(d) Reduction of Duty on Heavy Fuel Oils
(e) Removal of Duty on Powder, Flake and Blister Copper
(f) Inclusion of Copper and Cobalt Concentrates in Deferment Scheme
- Recommendations
- Conclusion
INTRODUCTION
Taxes are one of the major sources of Government revenue. Other sources of government resources may include support from cooperating partners in the form of grants, and borrowing either domestically or externally in the form of loans. The projected Government revenue are indicated in the Fifth National Development Plan 2006-2010. According to preliminary indications, Government is expected to raise 77% of its revenue from taxes and non tax measures, 18% from cooperating partner’s grants, and 5% from loans. The expected resource envelope to run government under the Fifth National Development Plan 2006-2010 is K62,623 billion[3]. The mining sector is the biggest money spinner in the economy and foreign exchange earner. Unfortunately, mining companies’ meagre tax contributions are depriving
Changes to the mining sector tax regime have occurred annually; in fact, the Mines and Minerals Act of 1996 was overhauled as recently as April 2008. The Income Tax Act, Value Added Tax Act and the Customs and Excise Act also endured recent changes. As a consequence of these frequent changes to the tax law, there exists a strong argument that the mining regime lacks stability and predictability. These changes come with both domestic and international costs to Government. Domestically, changes to the tax law that result in slashed taxes on mining companies risk alienating tax payers by depriving them of the benefits of the previous tax scheme before those benefits even materialize. Further, frequent changes in the tax regime erode investor confidence. It is a truism that investors are risk averse; they seek out countries characterized by a stable investment climate including tax regime. Flip-flops in the tax code, while perhaps pleasing to investors in the short term, ultimately threaten
It is therefore important that the consequences of changing the tax regime be fully considered before Parliament votes on the National budget’s proposal.
DISCUSSION OF PROPOSED TAX CHANGES
It should be known that if one in a given tax system does not pay his or her taxes, and then someone else will have to pay it in the long run. This creates a financing gap, causing Government to borrow today and raise taxes to offset the borrowing tomorrow. If this principle is true then we will proceed with this argument to analyse the budget speech.
It should be known that the mineral resources of are owned by its citizens.[4] If
Income Tax Measure- Remove the Windfall Tax[5]
From the design, the variable profit tax would kick in for any particular mine but after the company tax of 30% and when the company revenue become twice the cost of production then the windfall is effected at graduated levels at 25% of copper price at $2.50 to $2.99 and 50% at $3.00 to $3.49, and at 75% at any price at $3.50 and above.. This is the general parameter with no intersection. Where possible over lap were anticipated between variable profit tax and windfall tax allowable deductions were provided for.
The windfall tax captures significant tax revenue during high copper price periods. Since there are only two element of consideration i.e. the selling price and cost of production it’s easy to administer and it is a low cost approach on tax administration.
One of the major voids in our tax laws before April 2008 was the lack of resource rent on exploiting the mineral resource. The sole purpose of the variable profit tax and windfall tax was to give resource rent to the owners, the Zambians. When it comes to the resource rent, this should not be equalled to mineral royalty. Mineral royalty is allowable in
Removing windfall taxation is a long term cited position of the mining companies to take the benefit at a future date when the trigger positions are supposed to come into play. It should be recognised that in tax design, elements are not supposed to over lap (taxing one element more than once), in this case the variable profit tax and windfall taxation. The two variables have no overlap or intersection. The elements of consideration particularly the trigger in both variable profit tax and windfall tax are different and provide for both low and high cost mines to operate efficiently and improve in technology to their advantage. If this is the principle then the argument that the variable profit tax will capture some element of windfall taxation is not true.
Income Tax Measure- Allow Hedging Income[6]
Hedging is a normal business transaction were business risks are mitigated. Hedging in simple terms is an insurance portfolio taken by business to mitigate business risk. Therefore hedging is a risk management portfolio though it has an element of speculation which drives the risk.
In 2008, the budget speech stated that, ‘Hedging as a risk management mechanism shall be treated as a separate activity from mining’[7]. This is the correct legal practise under the Income Tax Act which is based on the principle of source rule and activity.
Hedging in practice is a complex transaction which would normally require at least two or more transaction portfolios. The transaction is even complex if these papers (covers of hedging) are drawn in a tax haven jurisdiction for taxes purposes.
Hedging is not a mining activity as such it will contradict the law. There is no justification then why the government should consider it as mining incentives under the 2009 national budget. It will bring a serious juridical conflict as other business undertaking hedging will require to e legally be recognised. This will create among other things erosion of the tax base.
Secondly we will be subjecting our tax base to speculation which history has shown that there is not meaningful gain. in tax design the tax base has to be clearly be defined for purposes of avoiding miss interpretation, avoidance of paying taxes through Non-Arms’ Length dealings and evasions.
Thirdly, hedging being a complex transaction, monitoring, assessing, final tax remittance processes would cause the cost of tax administration to go increase, with no corresponding benefit.
Income Tax Measure- Increase Capital Allowance[8]
Capital Allowance is the benefit that a company accrues in investing in capital equipment through a legally bound depreciation rule enshrined by law.
A twenty five percent (25%) capital allowance means that capital equipment will depreciate to scrap value after four calendar year. This is to say that every year for four years the equipment value is deducted by 25% of the initial cost. While a hundred percent (100%) capital allowance means that the initial cost of the equipment is deducted in the same year that the cost was made or when the equipment is bought.
In a twenty percent capital allowance scenario , 25% is deducted from the value of the capital equipment and other allowable costs, and when the revenues are higher, then the company declares a profit consequently taxes will be due. If this is not the case, the losses are moved to the following financial year as carry forward losses. In the case of 100% capital allowance, the taxes are only due when the equipment cost has been recovered by 100%.
This proposal would reverse the 2008 tax regime[9] gains that were introduced this is because the government will not have any revenue benefit until the company has recovered the full cost of the capital equipment. One wonders what benefit was envisaged last year which, just a year later no longer applies. It is assumed that the 2008 law was analysed in detail by the technocrats.
Business cycle is a natural pattern which involves business going up (booms) and going down (recessions). Business behaviour trends were the 100% capital allowance is in place show that companies will invest to a large extent during booms, allowing them to recoup their investment in a shorter time. Conversely, there are usually no investments during recession. The 100% will make the companies have an incentive not to invest when the copper prices are at the lowest because of prolonged periods to recover their cost. While the 25% was spreading the cost recovery evenly over a period of time meaning companies will invest when it is necessary unlike the 100%. It will then even mean that the companies will wait until the copper prices are high for them to start investing with an incentive that the can claim 100% capital allowance thus having the implication that the government will not benefit in times when there is high copper prices.
The above position should not be taken in isolation as other taxes such as VAT and Customs and Excise duty do not affect the mining sector on capital equipment. There are also other adverse implications on government revenue other than just the 100% capital allowance which will be discussed later.
Internationally this measure of 100% is very common to mainly countries in Africa, South of the Equator,
Customs and Excise Measures: Proposal on Reductions Duty on Heavy Fuel Oils[10]
The government has proposed to reduce customs duty on Heavy Fuel Oil from 30 to 15 percent.
The proposal is clearly intended to reduce the cost of doing business for mining companies. Heavy Fuel Oils (HFO) are largely consumed by the mining sector. With the global economy in recession, it is understandable that Government would want to support the mining sector.
However, the better route would be to review the current HFO duty on an annual basis. If the HFO duty is reduced permanently, the long term effect will be an erosion of the tax base for Government revenue and the need to amend the law (Statutory Instruments).
Customs and Excise Measures: proposal to removal of Duty on Powder, Flake and Blister Copper[11]
The government proposes to remove customs duty on copper powder, copper flakes and copper blisters.
Powder, flake and blister copper are above ninety percent copper content, and would be brought into the country for reprocessing to attain the refinement level of approximately 99.9% copper. In short, these materials are intended to enter the country for metal treatment. This incentive is proposed through an amendment to the Customs and Excise Bill.[12] However, the proposal directly conflict with the Mines and Minerals Act 2008, which makes a clear distinction between mining[13][14] It is disingenuous claim that the mining sector is being offered the incentive, just because the material in question is a base metal stock feed. In fact, the incentive is being offered to companies engaged in metal treatment.
International standard and best practise in mining has shown that metal treatment and mining are considered as two different sectors and enjoy different incentives. For
The proposed measure would immediately benefit the smelter companies. One of the difficulties that this measure will bring in the long term would be to create ambiguity as to whether it benefits mining companies or smelter companies, or both. Smelter have a lower cost of set up than developing a mine , it therefore follows that the heavier the cost the more the incentive- in this case the smelters companies will have a more incentive than the mining companies. If to the benefit accrues to both, then the next question must be whether metal treatment and mining are the same?
It is worthwhile to mention that mining companies with smelters also are controlled to ensure that they do not abandon the associated mine development costs which go with geological survey and mining development activities. However, if the cost of importation is lower than the existing cost of mining the ore and metallurgical processing combined, it would make business sense to import the prescribed stock feed for processing at the smelter plants. The effect for
The above measure will also increase the cost of tax administration with no corresponding revenue to the government at the time of importation.
Value Added Tax Measure s – Include Copper and Cobalt Concentrates on Deferment Scheme[15]
The government in addition to the above proposals to include copper and cobalt concentrates on the import deferment scheme for VAT purposes. This measure is no different from issues discussed under the customs duty on copper powder, copper flakes and copper blister.
Technically, all registered companies for VAT purposes who are none final consumers of taxable supplies and do not pay Value Added Tax on all taxable supplies they procure. This is true for all large scale mining companies in
However, this has a hidden cost to the mining companies and this is in terms of cash flow constraint for the period before the refund is actualised. This passes a benefit to Government in that the resources can be used for its operation without going to borrow. Some scholars have justified it as the benefit to the tax administration cost incurred by Government on VAT assessment taken which is also at a cost.
International standards and best practise in VAT deferment scheme has shown that this scheme creates long term benefits on capital equipment than on material in put or otherwise. This is so in the sense that capital equipment creates wealth and enhanced technological improvement.
Copper and cobalt concentrates are not capital equipment as such the should not be listed on the Deferment Scheme. Beyond that we see that there will be suffocation of mine development associated cost, no mineral loyalty paid, no resource rent and there will be an increased tax administration cost.
Historically in Zambia it has been noticed that the deferment scheme operates like it’s an unending give away tax revenues than it supposed to be a moratorium on taxes in a given business climate .
Combined Tax Measure Effects
The measures discussed above are a tip of the actual scenario. The most and biggest problem in the eyes of many people is to compare the taxes by their single elements as they are enshrined by different jurisdictions by law. The best common measure to compare taxes is to analyse the effective tax rate from one jurisdiction to another. What would be more interesting is that Government should be in a position to tell us what the proposed measure sums up to be as the effective tax rate for the mining sector in
Recently, one of the trade unions was quoted as having done a study on the mining sector and came up with a conclusion that it is not true that the mining companies were making losses.
Before the 2008 measures the mining sector tax contributions were only 3.75% out of the revenue inflows of two billion United States Dollars (US$ 2 billion). This was a meagre contribution and the 2008 measures further failed to contribute the estimated revenue[16] partly due to many issues. It is therefore apparent that with these incentives lined up for the mining sector, the owners of the resources, Zambians, should expect even a further reduced tax contribution from the collections of 2009. The Zambian people will be disadvantaged with the incentives if the are passed in parliaments.
Recommendation
It is our sincere hope that the honourable parliamentarians will stand with the concerns of the Zambian people by rejecting the measure there current form and presentation.
Conclusion
- The removal of windfall tax reduces the element to capture equitable resource rent with no corresponding compensation for the owners of the resources.
- Capital Allowance of 100% in the year incurred will not benefit the Zambians as the investors will only delay investment until they are sure that they will recoup their investment in the shortest possible time and these will only be in boom times. Capital allowance of 100%, carry forward of losses of ten (10) years is a good recipe to ensure that no resource rent is paid even in boom times.
- Hedging is a private risk management and allowing it for tax purposes will prove to be a complex exercise with not benefit to the Zambians as this may need huge financial and human capital investment with little no corresponding return in terms of taxes to be paid. If borrowing is capped by 3:1[17]-(Capital to debt ratio) to avoid unconventional dealings such as transfer pricing, while leaving speculation to the wind.
- The above measures are going to erode the tax base further measuring that our future generation will be born with debts on their heads.
- The people of Zambia are not currently benefiting from the huge mineral resources in the country and it more likely that the will be disadvantaged further from the above proposes made by the government
- Poverty is going to increase this year
[1] 2009 Budget Address, Ministry of Finance and National Planning,
[2] PWYP-Zambia, whose Secretariat is hosted by Caritas
[3] Fifth National Development Plan 2006-2010- Summary , Ministry of Finance and National Planning, 2006, Page 35
[4] See African Charter on Human and Peoples’ Rights
[5] 2009 Budget Address, Ministry of Finance and National Planning, 2009,
[6] 2009 Budget Address, Ministry of Finance and National Planning, 2009,
[7] 2008 Budget Address, Ministry of Finance and National Planning, 2008,
[8] 2009 Budget Address, Ministry of Finance and National Planning, 2009,
[9] 2008 Budget Address, Mininstry of Finanace and National Planning, 2008,
[10] 2009 Budget Address, Ministry of Finance and National Planning, 2009,
[11] 2009 Budget Address, Ministry of Finance and National Planning, 2009,
[12] National Assembly Bill ,2009
[13] The Mines and Minerals Act 2008
[14] The Mines and Minerals Act 2008
[15] 2009 Budget Address, Ministry of Finance and National Planning, 2009,
[16] 2009 Yellow Book, The Appropriation Act 2009, Ministry of Finance and National Planning, 2009,
[17] Income Tax Act
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