Mining Royalties: A Global Study of Their Impact on Investors, Government, and Civil Society

Evelyn Dietsche (Centre for Energy,Petroleum and Mineral Law and Policy, University of Dundee, Dundee, UKE‐mail: e.dietsche@dundee.ac.uk)

International Journal of Energy Sector Management

ISSN: 1750-6220

Article publication date: 27 June 2008

351

Citation

Dietsche, E. (2008), "Mining Royalties: A Global Study of Their Impact on Investors, Government, and Civil Society", International Journal of Energy Sector Management, Vol. 2 No. 2, pp. 297-300. https://doi.org/10.1108/17506220810883261

Publisher

:

Emerald Group Publishing Limited

Copyright © 2008, Emerald Group Publishing Limited


This book contributes to a collection of publications comparing mineral taxation regimes and instruments. The focus here is on mining royalties, an important but controversial tax instrument unique to the natural resources sector. In most countries, mining royalties are based on measures of quantity or value produced, rather then the profitability of a project or its income generated. This makes most types of royalties regressive tax instruments, which can contribute to inefficient resource exploitation and premature mine closures. In this book, leading mineral taxation experts tackle this complex topic with the objective to inform governments, companies and other stakeholders in their deliberations on the pros and cons of different types of royalties. BHP Billiton, the largest transnational mining company, has funded this work.

The book includes seven chapters. A brief introduction sets out the purpose, contributors and structure. It also alerts to the two conclusions, which are that the specific circumstances of each country are unique and that there can be no one‐size‐fits all approach to royalty tax. The authors caution against countries re‐examining their fiscal regimes and in particular royalty taxes in light of recent rises in global demand and prices. They presume emotive rationales for such re‐examinations and concerned about insufficient consideration given to potential negative effects on companies and shareholders. Against this background, the book sets out to provide a comprehensive, objective, and neutral analysis.

Chapter 2 introduces the reader to the taxation of the mineral sector and gives an overview of the issues covered by the literature to date. A first section addresses mineral taxation policy more generally, and a second section abstracts briefly the evolution of mineral tax regimes over time. The first subject covered is whether an optimal level of taxation and mix of tax instruments can be identified in theory, based on the typical assumption made regarding company and government objectives. The authors then stress the problem of obsolete bargaining and, related to this, the importance of fiscal stability in light of populist calls advocating tax increases for large foreign companies. Also summarised are the special characteristics of the industry and the tax implications drawn from these. This includes a discussion on the basic rationale for imposing royalty tax.

The chapter then moves on to a comprehensive discussion of the concept of resource rents and the policy conclusion that governments can remove such rents without altering current decisions on production and consumption. Different sub‐components of overall resource rents are identified to demonstrate the concern that in light of price volatility governments may confuse short‐ with long‐term rent components. This is followed by an overview of different tax types, their purposes, and their prevalence. The authors stress in particular the importance of comparing tax bases rather than tax rates, and of assessing the cumulative effects of different tax types integrated into an overall regime.

The description of the evolution of regimes covers the past 20‐30 years and highlights the trend to reduce indirect taxes and place greater importance on direct taxes. A shift towards profit‐ and income‐based royalties has been observed in countries with competent tax administrations. Chapter 2 however concludes that there is no discernible cross‐country convergence, neither in tax regimes nor the application of specific types of royalties.

Chapters 3 and 4 zoom in on royalties. Chapter 3 describes the three broad royalty families – unit‐, value‐ and profit/income‐based – and associated assessment methods. The chapter gives examples of legal provisions and comparative calculations for nine stylised royalty types applying different bases and rates. It also discusses trade‐offs between administrative transaction costs and different government objectives and describes procedural steps in administration and collection. A descriptive comparison of royalties by regions and countries is also included. The authors note a wide variety of different approaches and call on idiosyncratic variables to condition each country's approach. The chapter furthermore includes a description of private party royalties.

Chapter 4 adopts a project economics perspective. It compares the royalty types introduced in Chapter 3 on the basis of three hypothetical mine models, each featuring economic and physical characteristics of relevance to the royalty calculations. The models include an underground gold mine, an open‐pit copper mine and an open‐pit bauxite mine. A common set of assumptions on other taxes and permissible deductions as well as three different price scenarios are applied to compute four common assessment criteria. Selected quantitative results are presented and explained. The detailed results feature in the appendices included in the book's accompanying CD.

Complex royalty and tax effects on interrelated production parameters such as mine cut‐off grade, reserves and mine life are also discussed in this chapter. Using the copper model, the imposition of royalty tax is considered as a cost in determining the economically optimal design of a royalty system for maximising either a project's NPV or its overall wealth for shareholders. The chapter concludes with the caveat to take great care in applying the generic models, because the illustrations based on them do not yield optimal results for all mines. But, they can help policy makers understand how companies use similar models in their decision making and evaluate the possible affects of different types and rate levels.

Chapter 5 seeks to address the broader implications of royalty taxes for investors, civil society, the market and governments. It starts with a brief narrative on the emphasis on competitive fiscal terms in the 1980s and 1990s followed by five narrative case studies on two countries with favourable and three countries with less‐favourable investment climates. The findings for the countries with favourable terms are inconclusive, while for the other three it is concluded that royalty tax have had a negative impact on investments. However, an explicit framework supporting the case selection and excluding the possibility that unidentified third variables can explain the variance in outcomes is not presented. The reminder of this chapter follows in this spirit. Four sub‐sections seek to allude to the implications of royalty taxes on the investment climate and the impacts on civil society, on the market and on host countries and governments. The discussions under these sub‐sections are predominately descriptive or prescriptive and lack explicit analytical propositions validated through empirical testing. The implicit conclusion towards the end of the chapter is that mineral royalties may or may not have a positive or negative effect on economic growth and development. It could be argued that this chapter reflects the mineral taxation literature more generally. There are few theoretical propositions, more perception‐based policy assertions and little empirical testing of clearly stated policy hypotheses. One reasons for this may be that there is little comparable data on the revenue and other potential benefits generated by the industry. Another reason is that the long and short‐term interests and the political‐administrative capabilities of host governments are only ever assumed and not made the subject of enquiry.

Chapter 6 moves away from focusing on royalty tax and seeks to link the internationally debated keywords transparency and governments to mining sector taxation. The case for transparency is made against the background of a selective reading of the resource curse literature emphasising civil strife and corruption. This is followed by a listing of general principles for disclosure and reporting posted in the form of questions such as, how relevant is the information disclosed. Some challenges are also highlighted, including practical limitations to the call for full disclosure of mining companies' tax payments and the contents of mineral development agreements. The chapter also highlights challenges faced in harmonising accounting across countries and applying within host countries accounting, auditing and reporting standards as well as capturing not only tax payments but also other benefit streams. The chapter concludes with a mining focused summary of the extractive industry transparency initiative and a series of emerging lessons posed as questions to which there appear to be no answers yet.

Chapter 7 summarises the contents of each of the previous five chapters and concludes with a set of recommendations and best practices. These stress again the uniqueness of each nation's varying circumstances and the limitations that these pose on devising an optimal royalty tax. Eight recommendations appeal to considering the cumulative impact of taxes, weighing off short‐ and long‐term benefits, engaging in dialogue with the industry on government policy decisions, sharing directly the benefits of mining with local communities, acknowledging administrative efficiency and institutional capacity issues in the choice over fiscal instruments, promoting transparency and accountability, and balancing taxation with incentives for attracting investment to maximise the net present value of the social benefits flowing from the mineral sector over the long run.

The four appendices provided on a CD provide:

  1. 1.

    snap‐shot samples of royalty provisions extracted from laws and regulations of about 39 jurisdictions;

  2. 2.

    spreadsheets detailing the financial calculations of the book's quantitative assessment of different royalty methods;

  3. 3.

    comparative country information on royalty administration and collection regimes; and

  4. 4.

    comparative country information on the collection and appropriation of royalties at different tiers of government.

In summary, this publication provides a wealth of descriptive information. In Chapter 2, it gives a general overview of mineral taxation. Chapters 3 and 4 provide a very insightful quantitative comparison of various types of royalties modelled on practical examples and the financial impacts they render under different physical, price and financial scenarios. Chapters 5 and 6 are less convincing and fall short of an analysis of why some mining countries are (and others are not) re‐examining their fiscal regimes and are considering or have re‐introduced royalty tax. This points to a more general gap in the mineral taxation literature. Unlike the tax literature for other economic sectors, this literature pays no attention to identifying the factors that condition host countries' short and long‐term interests and the impact on tax policy decisions. The concern that this book raises regarding the potential negative impact of royalties is indeed well warranted. Its conclusions that each country is unique, that there is no one‐size‐fits all approach, and that ultimately prevailing domestic political processes determine outcomes (p. 30) would appear to be of incomplete help to investors, governments, and civil society.

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