May 23, 2017 - Written by FSG Intern, Gabriel Toledo
Over the last decade, several mineral-rich countries have enacted fiscal reforms that increased costs to the mining industry. It is critical for senior managers to consider the impact of fiscal regulations over net profits as they discuss new market-entry/exit strategies.
Taxes represent, on average, 35% of a mining firm’s earnings before interests, taxes, depreciation and amortization (EBITDA). Figure one shows the average cost of taxes in a set of 18 countries. Given that taxation varies significantly from country to country, the fiscal environment of a country of operation can be just as important to profitability as the productivity and cost-effectiveness of mineral extraction.
While mining companies have vast experience monetizing unextracted mineral resources, tax rates and collection methods change over time. Changes in fiscal regimes could alter significantly discounted-cash-flow models used to assess the financial viability of a project. Market intelligence that provides insight into the future course of government fiscal and tax policy can help mining executives estimate future costs and investments.
Traditional taxes are just the beginning
Mining firms need to comply with traditional fiscal obligations such as corporate income and withholding taxes. The corporate income tax (CIT) is a levy placed on a company’s profits while withholding taxes are royalties imposed on income generated by financial securities, generally stocks and bonds. Figure two shows the CIT rate in the same set of countries.
Mining-specific taxes vary considerably
Firms should evaluate potential changes in corporate income tax alongside taxes targeting the mining industry. Figure 3 shows taxes applied to the sale of copper, gold, coal and iron ore. Canada imposes a 17% tax rate across the board, the highest in this assessment (although its corporate tax rate is moderate) while in the case of Brazil taxation varies between 1% and 2% (but its corporate tax rate is among the highest).
Managing the cost of compliance
The complexity of fiscal regimes can impose additional cost. A mineral tax regime that is simple and clearly stated in the legislative system is generally preferred as it reduces administrative costs and misinterpretation. A survey by the Fraser Institute revealed that mining executives listed the United States, Canada and Australia as the most attractive fiscal regimes. While these three countries impose less competitive tax rates, they offer transparency, clarity and efficiency to tax payers.
Mining companies should factor in the opportunity cost of familiarizing themselves with a new tax regime. A less-ambitious fiscal regime can appear as a cheaper choice, yet the administrative costs that go with it may be more expensive in the long-run.
On occasion, private companies may negotiate more-advantageous bilateral tax deals with local governments. Such agreements can be beneficial in the short term, nonetheless they are usually subject to modifications as they are not set in the legislative system.
Assess potential for future disruption
Executives should remember that mining taxation can change dramatically in emerging markets. Should governments expect mineral prices to remain low over the long-term they are likely to eliminate taxation to attract new investors, yet once prices go back up, they may face political pressure to reverse their previous policy. Mining companies should include changes in the fiscal regime as part of their sensitivity analysis when constructing financial models.
In addition, firms should consider economic stability and political risk as they assess new market opportunities. Firms can stay updated on all these events through FSG’ Global Outlook and Events to Watch reports. Lastly, firms interested in selecting the optimal mining market can benefit from FSG’s market prioritization methodology which assesses the political, demographic and macroeconomic conditions in emerging markets.
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