BASE METAL AND GOLD MINE TAXATION IN SIX NATIONS
ARTHUR LAKES LIBRARY
COLORADO SCHOOL OF IWNES
GOLDEN, CO 80401
by
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A thesis submitted to the Faculty and Board of Trustees of the Colorado School of Hines in partial
fulfillment of the requirements for the degree of Master of Science (Mineral Economics).
Golden, Colorado Date Signed Douglas H. Brown Approved Dr . T .D . Kaufmann Thesis Advisor Golden, Colorado Date
if
. John E. Tiltonrofessor and Head
pf.
John E. TiltonProfessor and Head,
AgSIB&gE
This study provides a quantitative comparison of mine taxation in six nations— the United States, Chile, Mexico, The Philippines, Malaysia, and Papua New Guinea (PNG)— from the vantage point of a U.S. mining firm. The basis of this comparison was the hypothetical construction and operation of an identical copper and gold mine in each nation.
Taxes and government compensation were based on
published tax codes announced as of July 1989 and include local and national income taxes, dividend and interest withholding taxes, royalties, free equity, minimum taxes, additional profits taxes, and asset-based taxes.
The primary yardstick used to compare taxation between the various nations studied was the percentage of pretax discounted cash flow absorbed by the various taxes imposed. This yardstick is referred to as the effective tax rate.
The lowest calculated effective tax rate imposed upon the hypothetical U.S. mining firm was found in its own
country (38 percent), with the highest being found in Mexico (90 percent) under base case assumptions. The
attractiveness of mining in the United States to a U.S. firm is largely the result of the absence of dividend withholding taxes placed upon intra-nation payments. Chile and PNG were
found to have the most attractive tax structure outside the United States, with average effective tax rates of 58
percent and 63 percent respectively.
In all nations examined, the effective tax rate was
found to fall as mine profitability was increased. It is
apparent, however, that a minimum tax level is approached asymptotically as profitability is increased; this lower "resistance” level of effective taxation was found to
average 51 percent in the case of copper and 57 percent in the case of gold in the six nations examined.
A distinct correlation, often commodity independent, is also identified in this research between mine profitability
(as measured by the pretax internal rate of return in
TABLE OF CONTENTS
P a ge
ABSTRACT ... iii LIST OF F I G U R E S ... viii LIST OF T A B L E S ... . . * . X ACKNOWLEDGMENTS ... xii Chapter 1. INTRODUCTION... 1 2. M E T H O D O L O G Y ... 16 The Mine M o d e l ... 17 Deposit Characteristics ... 18Mine Operating Parameters ... 21
Gold Mine Characteristics . . . 22
Copper Mine Characteristics . . 22
The Financial Evaluation Model... 25
Corporate Structure ... 27
Financial Structure ... 29
Mine Sensitivity Analysis ... 30
3. TAXATION IN NATIONS EXAMINED ... 31
O v e r v i e w ... 31 Application of Tax C o d e s ... 32 Papua New G u i n e a ... 35 The P h i l i p p i n e s ... 37 M e x i c o ... 39 C h i l e ... 43 M a l a y s i a ... 45 United States ... 48 v
Eage
Taxation of U.S. Operations . . 48
U.S. Taxation of Foreign O p e r a t i o n s ... 49
Effective Tax R a t e s ... 51
The Gold M o d e l ... 52
The Copper M o d e l ... 56
4. COMPARISON OF BASE CASE R E S U L T S ... 61
Comparative Returns ... 61
Returns to the Corporation... 62
Hypothetical Gold Mine . . . . 63
Hypothetical Copper Mine . . . 65
5. SENSITIVITY ANALYSIS . . . ... 70
Taxation and Metals Price ... 70
Taxation and Operating C o s t ... 73
Taxation and Capital C o s t ... 73
Taxation and Project D e b t ... 77
6. CONSIDERATION OF RESULTS AND COMPARISON WITH PAST R E S E A R C H ... 83
A Resistance Tax Level? ... 84
Effective Taxes and Project Profitability ... 97
Comparison with Past R e s e a r c h ... 106
7. C O N C L U S I O N S ... 112
REFERENCES CITED ... 117
Appendix A: GOLD AND COPPER DEPOSIT SUMMARY . . 119
Appendix B: MINE CAPITAL AND OPERATING COST E S T I M A T E S ... 124
P a g e
Appendix C: HYPOTHETICAL GOLD AND COPPER
MINE EXAMPLE CASH F L O W S ... 130
Appendix D: DISCOUNT RATE SENSITIVITY ... 139
Appendix E: COMPARISON OF NATIONAL TAX STRUCTURES AND RETURNS TO
MINING NATIONS ... 142
LIST OF FIGURES
Figure
Eage
1 Unit Gold Tax: Base Case Assumptions . . 55
2 Unit Copper Tax: Base Case Assumptions ... 58
3 Corporate Cash Flows: Gold M i n e ... 66
4 Corporate Cash Flows: Copper Mine . . . . 69
5 Change in NPV per 1% Increase in Debt: Gold M i n e ... 80
6 Change in NPV per 1% Increase in Debt: Copper M i n e ... 82
7 Chilean Tax Resistance Levels ... 89
8 Malaysian Tax Resistance Levels ... 90
9 Mexican Resistance Levels ... 92
10 Philippine Tax Resistance Levels . . . . 93
11 PNG Tax Resistance L e v e l s ... 94
12 USA Tax Resistance L e v e l s ... 96
13 Effective Tax vs. Pretax IRR: Chile . . . 99
14 Effective Tax vs. Pretax IRR: M a l a y s i a ... 101
15 Effective Tax vs. Pretax IRR: Mexico . . 103
16 Effective Tax vs. Pretax IRR: Philippines... 104
17 Effective Tax vs. Pretax IRR: PNG . . . . 105
Figure Eage
18 Effective Tax vs. Pretax IRR: USA . . . . 107
klgT OF TABLES
Table Eage
1 Copper Deposit Characteristics in
Nations Examined ... 19
2 Gold Deposit Characteristics in
Nations Examined... 20
3 Hypothetical Gold Mine
Characteristics ... 23
4 Hypothetical Copper Mine
Characteristics ... 26
5 Tax Structure in Nations Examined . . . . 33
6 Mining Tax Codes in Papua New Guinea . . 36
7 Mining Tax Codes in The Philippines . . . 38
8 Mining Tax Codes in M e x i c o ... 41
9 Mining Tax Codes in C h i l e ... 44
10 Mining Tax Codes in M a l a y s i a .... 46
11 Mining Tax Codes in the U S A ... 50
12 Effective Taxation in Nations Examined:
Gold Mine: Base Case Assumptions . . . 53
13 Effective Taxation in Nations Examined:
Copper Mine: Base Case Assumptions . . 57
14 Comparison of Corporate Returns:
Gold M i n e ... 64
15 Comparison of Corporate Returns:
Copper M i n e ... 67
16 Sensitivity of Effective Tax Rates to
Metals Price Variation ... 72
Table Page
17 Sensitivity of Effective Tax Rates to
Operating Cost Variation ... 74
18 Sensitivity of Effective Tax Rates to
Capital Cost V a r i a t i o n ... . 76
19 Sensitivity of Effective Tax Rates to
Project Debt Variation ... 79
20 Apparent Tax Resistance Level:
Hypothetical Gold M i n e ... 86
21 Apparent Tax Resistance Level:
Hypothetical Copper Mine ... 87
22 Summary of Corporate Taxation ... 113
ACKNOWLEDGMENTS
The author would like to express his appreciation to Dr. Thomas Kaufmann who has supported and guided my efforts in the compilation of this document as well as throughout my
studies over the past five years. I would also like to
thank my thesis committee and Lita Dunham for their suggestions and patience during the preparation of this
document. Generous support to this research was also
provided by the East-West Center's Mineral Policy Program and its members.
Finally, my sincere thanks go to my parents who have encouraged my education since I was very young and to my wife, Kathryn, and son, Maxfield, who endured more than a few dull evenings in order to produce this thesis.
Chapter 1 INTRODUCTION
Multinational mining companies base their foreign investment decisions upon the host nation's resource
endowment, political stability, bureaucratic efficiency, and
investment climate. From a corporate perspective, a
nation's investment climate is highly dependent upon the structure and stability of taxation. Other factors which may influence direct investment include currency stability and convertibility, the availability of skilled labor, and national participation in major treaty organizations.
The mining investment climate in many developing countries has improved dramatically over the past decade, particularly with respect to taxation (Walde 1988). Factors which encouraged many nations to adopt a more pragmatic
attitude toward foreign mining investment include rising national debt levels in many nations, a trend away from socialistic development policies (toward open market
development policies, following the Asian example), and a prolonged decline in commodity prices during the early
1980s.
Major changes in the structure of taxation have also
United States, the 1986 tax reform act drastically altered the structure of mining incentives by eliminating the
investment tax credit and by introducing alternative minimum tax provisions. Corporate tax rates were also lowered and many deductions have been eliminated. Similar tax reforms have been enacted in Canada.
Among developing nations, sweeping tax and investment reforms have taken place in Mexico (1986), the Philippines
(1989), and Malaysia (1989), to name a few. These
comprehensive tax reform measures generally lowered the
maximum corporate income tax rates and restructured existing
investment incentives. In many developing nations, export
incentives have replaced import substitution incentives. In addition to broad tax reform, many nations are now examining regulations and taxes regarding the natural
resource industry. In Mexico, Malaysia, and the
Philippines, increased levels of foreign ownership are now allowed. The Philippines instituted a new mining policy and taxation structure in 1989, and Malaysian mining policy is currently under review by the United Nations with the intent of comprehensive reform.
Purpose of Study
The importance of mining taxation structure in attracting foreign investment and in extracting mineral
rents from rich national endowments is widely recognized and has been the focus of extensive research. Much of this
research has focused on the optimization of tax structures to provide the greatest benefit to the nation without unduly burdening the foreign investor.
In this study, mining taxation is examined from the vantage point of a multinational mining firm seeking to
maximize the net present value of its investment. The study determines aftertax returns to the hypothetical corporation on identical gold and copper mines in six nations with the intent of deciding (all other things equal) which of the six should be targeted for exploration and acquisition funding. Tax structure is only one component of a larger picture, and a corporation seeking to maximize its returns on mineral exploration and acquisitions would undoubtedly review many other factors before making a decision.
The intent of this research is, therefore to describe the current tax structure in each of the six nations and to
believed that this effort, which is by no means original in its approach, is of value for the following reasons:
1. The impact of recent changes in tax structures
worldwide has not been examined quantitatively with respect to the mining industry. The latest
quantitative effort the author is aware of was
completed in 1986 (Brewer et al.) before many of the recent reforms in taxation.
2. This study differs from many past research efforts in
that it will focus upon returns to the corporation not
returns to the nation. Furthermore, past efforts to
quantify and compare mining taxation have often excluded the impact of downstream taxes such as
dividend withholding and taxes accruing to the parent corporation in its home country.
3. This research will incorporate a relatively short lived
gold mine as well as a "classic” large base metal mining project with an extensive life. Few, if any, quantitative analysis of mining taxation have examined gold mines or mines with short lives and relatively low capital costs.
4. The methodology employed includes the nation by nation
evaluation of many factors commonly assumed to be benign in past research efforts such as depreciation, state and local taxes, royalties, and dividend and interest withholding taxes.
Following is a discussion of the salient features of common mining taxation structures as well as a review of past quantitative efforts to compare mining taxation.
Chapter 2 will describe the mine and financial model used to compare taxation in this thesis and outline the major assumptions of the model. Chapter 3 will review the
features and application of the tax codes in the six nations examined, and will present the result of the base case model for each nation.
Chapter 4 will review base case results as they apply to the project's return to the U.S. corporation. In
addition, chapter 4 will contrast taxation for the gold and copper project. The effect of variation in operating and capital costs, metal prices, and debt-to-equity ratios on the results presented in chapter 4 are discussed in chapter 5.
The potential implications of this research are
discussed in chapter 6 with conclusions presented in chapter 7. Appendixes provide information concerning the mine and financial model, a summary of project returns to the nations
(as opposed to the corporation), and a comparison of tax structures in each nation.
Aspects of Mining Taxation
Revenues accruing from mining ventures are shared by the government in three major ways: income or profit-based taxes, quantity or value based taxes, and through the
mandatory allocation of project equity to the government on
a concessionary basis. An infinite range of hybrid tax
forms have developed over time, which encompass aspects of
all three basic forms of taxation noted above. Income sent from one country to another is often subject to a dividend tax, which introduces another tax burden for the
international corporation.
Income-Based Taxation
The largest portion of a profitable mine's tax burden is composed of income-based or profit-based taxes. Both the method of calculating taxable income as well as the rate of income taxation vary widely. In recent years, published income tax rates have fallen from roughly 50 percent in many nations to 35 percent, although this decline has been
mirrored by a noticeable reduction in allowable deductions against taxable income.
Most investment incentives offered by nations are structured so as to reduce taxable income. Common
incentives include accelerated depreciation of assets, tax holidays or reductions following production startup, and the allowed deduction of quasi expenses such as loan interest and (in some cases) other taxes.
Variations on income-based taxation include the
imposition of minimum taxes whereby the government provides deductions against taxable income with one measure and
1imitation is commonly applied as a percentage of operating income but may be based upon a nonincome related factor such as asset value. The calculation and subsequent
recalculation of taxes for alternative minimum tax provisions is often arduous.
Another variation of income-based taxation unique to the resource industry is additional profits taxes (APT), or the resource rent tax. The intent of this income-based tax is to extract rents generated by a resource which is
exceptionally rich or to extract additional tax revenue from mines which are enjoying excessive profits owing to high
mineral prices. In its classic form, the resource rent tax
will only accrue to investors once a specified rate of return has been reached on their investments.
Additional profits taxes are applied in relatively few nations to the mining industry, but are common in the
petroleum industry. Major mining nations incorporating an APT currently include Papua New Guinea (PNG), Indonesia, and Botswana.
Withholding Taxes
Withholding taxes are levied on funds transferred from one nation to another. These taxes may be imposed on loan interest payments, royalties, fees, and most commonly, on
repatriated funds in the form of dividends. Withholding taxes are commonly high in nations with balance of payments problems due to high levels of foreign debt and may be used to discourage the outflow of funds which could in theory, be reinvested in that nation. Typical withholding rates range between 15 percent and 20 percent, although some nations levy higher rates. Chile for example, imposes an effective dividend tax of 30 percent but has an extremely low
corporate tax of only 10 percent.
Many nations have established treaties regarding inter nation withholding tax rates for various types of funds. In the United States, foreign withholding taxes paid on
dividends (but not interest) are applied against U.S. taxes
due by a multinational corporation. Interest and other non
income withholding taxes are normally treated as an expense by U.S. tax authorities.
Quantity or Value-based Taxes
Despite years of scolding by mining industry advocates and policy analysts, many national and regional governments continue to levy quantity or value-based royalties
(alternately referred to as severance taxes or ad valorem taxes) upon mining ventures. The major attraction of such a tax to the government is that it provides a steady source of
income in good times and bad. In addition, it is simple to calculate and, as nothing is deductible against it, easy to police.
To the mining company, such a tax represents a variable cost of business which commonly ranges between 1 percent and 5 percent of the mine's annual revenue. Arguments posed against this form of taxation center on its potential to discourage marginal mine development, to raise the optimal cut-off grade to be mined, and its potential to force a mine to close prematurely. Fortunately, most nations treat
royalty payments as a business expense and allow their deduction against national income taxes.
Many nations— the United States (Arizona), the Philippines, and Malaysia, for example— displayed the
foresight to lower or temporarily abolish these taxes during
the early 1980s when metal prices were low. In fact, the
royalty rate in the Philippines has been one of the best barometers of metals prices available since the early 1970s, changing as often as twice a month at times.
Government JBauitv Arrangements
During the negotiation of mining concession agreements, one increasingly common ingredient has been the inclusion of a provision for state equity participation. From the
viewpoint of a corporation, there should be no real disincentive from this proposal if the government contributes fully to all initial and ongoing capital
expenditures. If the government seeks to have nonrecourse
equity, that is, to share in the project's cash flows but not to support its capital requirements and operating losses, then this equity is in essence a tax to the corporation.
The arrangements negotiated for government equity range from required free and nonrecourse equity (Malaysia, for example), to governments which act as a normal partner in the venture (PNG). In some cases equity is "earned” by the government through the deferral of taxes or by the provision of certain infrastructure.
Minina Taxation Studies
As mentioned, mining taxation has been the subject of a great deal of examination over the years. Qualitative
analysis has dealt with, among other issues, the description of the effects of various tax regimes by way of case studies of taxation in certain nations (see, for example, Emerson
1984). In addition, a number of research efforts have been
devoted to evaluating the impact of specific tax structures such as royalties and additional profits taxes upon the
distribution of project gains under a variety of alternative sensitivity models- (see, for example, Palmer 1980 and
Radetzki 1987)
Several excellent summaries of mining taxes and their implications have also been compiled in recent years, (see, for example, Faber 1982) Finally, a great deal of work has been carried out by international organizations concerning contractual arrangements (Virmani 1985; UNCTC 1985) and the linkages between mining and national economic development. (Gluschke, Iwase, and Zorn 1980).
Quantitative cross-county comparison of mining taxation similar to that contained in this thesis has been limited. The number of assumptions required to conduct a cross-nation comparison including the creation of a hypothetical mine
(which could possibly be found in each nation) and the interpretation of tax codes which are often inaccessible, excessively vague, and subject to discretionary action have necessarily limited the breadth and depth of past research.
At least three studies conducted during the 1980s have quantified and compared taxation in several nations using a methodology similar to this study. The most recent, based upon taxes as of March 1986, was conducted on behalf of the Canadian Department of Energy, Mines, and Natural Resources
hypothetical mine--a large copper and gold deposit— which has a 15 percent pretax internal rate of return (IRR) in each of ten countries and evaluates the impact of income taxation on each mine.
Brewer's study defines the net present value of taxes divided by the net present value of total project cash flows as the effective tax rate and uses this as a measure of
comparison between nations. The study performs its
evaluation under cyclical price scenarios as well as under several different assumptions regarding inflation and
project IRR. In all cases, particular attention is paid to the level of incentives offered by depreciation and various income-based deductions.
Major observations in Brewer's study are that most tax structures examined are regressive (the rate of taxation varies indirectly with profitability), that capital recovery allowances are by far the most important incentive available to the mining industry, and that rapid inflation may reduce the benefit of capital recovery incentives.
The relevancy of Brewer's study to this research, however is limited by three aspects of his research:
1. Only income-based taxes were analyzed, with no
provision having been made for royalties and/or government equity.
2. The study assumes that the project is financed by 100 percent equity with no outstanding debt.
3. Funds are not repatriated to a parent corporation and
no withholding taxes are paid.
Despite these differences, Brewer's work is of interest and the results of his study are contrasted to the conclusions of this thesis in chapter 6.
A second quantitative effort in the 1980s examined mining taxation using a hypothetical mine in seven South
American nations. (Roman & Allen 1987) Tax codes from 1982
through 1985 were used. The project examined was a large, integrated, copper project producing roughly 100,000 metric tonnes a year. The study concluded that there was very
little difference in the effect of taxation upon the project in each nation. Assumptions incorporated into the analysis included identical depreciation allowances in each nation, a 100 percent equity basis, and no repatriation of funds.
The final 1980s study, similar in methodology to this thesis, examined mining taxation in PNG, the Philippines, and Indonesia. (Wilson, 1984) The study used a hypothetical copper mine and Monte Carlo simulation to determine a most likely probability outcome for mine profitability under each tax structure. Wilson's analysis is painstaking in its
his analysis with the exception of parent company home taxes and withholding taxes. He concludes, based upon probability outcomes, that the additional profits tax enforced in PNG is the most favorable to the investor facing the uncertainties inherent in mining. In addition, he is critical of the Philippines for its imposition of high royalties.
It should also be noted that several major accounting firms such as Coopers & Lybrand and Price Waterhouse publish periodic summaries of mining and national tax codes in major mining nations. Several of these summaries have been
crucial to the author's understanding of the calculation of certain aspects of tax codes. Coopers & Lybrand have also from time to time published cross-nation studies of mining taxation. The most recent focused upon industrialized mining nations. (Coopers & Lybrand, 1985)
A more novel research approach has been taken with respect to Canadian taxation: the hypothetical re-mining of deposits discovered in Canada between 1951 and 1974 given the nation's current tax codes. This study (Mackenzie and Bilodeau, 1979) criticizes the hypothetical mine approach used in this thesis on the grounds that variation in deposit type is an important characteristic of the mining industry which is relevant to the examination of its tax structure. While Mackenzie provides a fervent argument on this point,
it would seem that individual mines fundamentally vary only in terms of their profitability (from the viewpoint of tax collectors and corporate shareholders at least). Mine profitability, in turn, can be adequately simulated using sensitivity parameters such as operating and capital costs.
Chapter 2 METHODOLOGY
Five mineral rich, developing nations— Chile, Mexico, Malaysia, the Philippines, and Papua New Guinea (PNG)— were
selected for comparison of mining tax regimes based on their mineral potential, diversity of taxation, and the author's perception of their current attractiveness to foreign
investment. Certain industrialized nations— such as
Australia and Canada— are also the focus of mining activity and would be interesting subjects for further research.
In each nation, two hypothetical mines— a large scale, open pit copper mine and the other a small, surface gold mine— were assumed to be developed, operated, and taxed according to each nation's published tax codes. Operating parameters were considered to be identical in each nation. Returns on these properties were measured from the vantage point of a parent company located in the United States.
These same mines were also assumed to be located, developed, and operated in the United States (Arizona) for further
comparison.
It should also be mentioned that one assumption
implicit in this analysis is that variation in taxation does not effect the rate of output, cost structure, or sales
policy of the project. The author acknowledges that,
although this assumption is convenient, it may not be valid in the long run.
The analysis of the results of the various models
constructed in this thesis centers on the ranking of project returns to a U.S. corporation. The impact of incentives and/or disincentives contained in each nation's tax codes is also analyzed. The differences in the structure of taxation in each nation is addressed in appendix E. It should be noted that taxes are continually in change and that this research is, at best, a snapshot of taxation in 1989.
Sensitivity analysis was included in this study as the structure of resource taxation is likely to be dependent upon national resource potential as well as capital and operating costs. By varying hypothetical mine parameters systematically, it is possible to establish a relationship between each parameter and taxation, as well as a more general relationship between mine profitability and effective tax rates.
The Mine Model
The hypothetical gold and copper mines evaluated under each nation's tax code is assumed to have identical geologic characteristics, capital costs, operating costs,
transportation costs, and market structure. Deposit
characteristics are based on the average characteristics of copper and gold deposits in the six nations examined.
To simplify the analysis, neither the copper nor gold operations are assumed to be integrated with downstream processing facilities. The principal product of the copper mine is bulk concentrate which is smelted and refined under a toll contract. The gold mine is assumed to produce and toll refine gold dore. All mine sales are assumed to take place at "arms length11 implying that revenues accrue to the mine according to the fair market value of the product.
Deposit Characteristics
To provide the most reasonable set of geologic and mine operating parameters, the hypothetical deposit modeled in this analysis is based on cross-nation averages of known surface copper and gold deposits for the five developing
nations examined. Specifically, reserve size, ore grade,
stripping ratio, and yearly production rate for average copper and gold mines in the five developing nations examined were used to construct the hypothetical mine
(tables 1 and 2). Appendix A contains a summary of the mines and deposits used to arrive at each nation's average.
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So u r c e s ; C o x , R . , an d B r a d s h a w , P . M . D . , " G o l d in th e S . W . P a c i f i c , " M i n i n g Ma ga z i ne , Ma y 1 9 8 8 ? P h i l i p p i n e M i n i n g & E n g i n e e r i n g Jo ur nal , ( v a r i o u s i s s u e s ) ; M i n i n a A n n u a l R e v i e w 1 9 8 9 ? Go l d 19 89. C o n s o l i d a t e d G o l d f i e l d s , L o n d o n .The hypothetical gold and copper mine's parameters, as based upon the five-nation averages, do not precisely mirror the resource potential of any one nation. This method of estimation method does, however, provide an unbiased and rational point of departure for this study. Variation between each nation's actual resource potential and the hypothetical mine model is compensated for, in part, by sensitivity analysis.
Mine Operating Parameters
The yearly production rate used for both the copper and gold mine was based upon the five-nation average determined above, as was the stripping ratio and average grade of ore mined. Mine life was determined by dividing reserves by annual production. Metal recovery rates were assumed to be equal in all nations.
Operating and capital cost estimates for both
operations were based upon the U.S. Bureau of Mines Cost Estimating System (1987), a widely available cost reference source. Cost estimates were adjusted to 1989 dollars based on the U.S. Producer Price Index. The author acknowledges that the use of both the U.S. Bureau of Mines estimates and the Producer Price Index may not present an accurate view of costs in various areas of the world.
Gold Mine Characteristics. The gold deposit mined in each country was assumed to be developed over a two-year period with an eight-year production life. In general, it was assumed that this deposit was mined with a minimum of capital and operating cost. The only infrastructure
required for the gold mine in each country is assumed to be a 40-kilometer unpaved road to the site.
The annual production rate from the mine is assumed to be 825,000 metric tons of ore, 30 percent of which is low- grade ore best suited for heap leaching. The remaining 70 percent of the mine's annual ore production is assumed to be processed in a carbon-in-pulp (CIP) plant. Annual
production of recoverable gold is roughly 74,000 ounces, making the mine a significant, but not quite world-class gold producer.
Table 3 provides an overview of the salient features of the hypothetical gold mine used in this analysis. Detailed cost estimation parameters are provided in Appendix B for both the gold and copper mine.
Copper Mine Characteristics. The deposit modeled for this analysis is developed over a 5-year period and has sufficient reserves to continue mining for 33 years? a 20- year production life was used for simplicity. No salvage
TABLE 3
Hypothetical Gold Mine Characteristics
Mine, Parameters ? Reserves Grade Mining Rate Recovery Rate Mill Leach Recoverable Metal 6.800.0000 metric tons 0.11 ounces per ton gold 0.14 ounces per ton silver 825.000 tons ore per year 4.290.000 tons waste per year
87% Gold, 65% Silver 55% Gold, 0% Silver
74,423 ounces gold per year 52,553 ounces silver per year
Operating Costs* Mining Processing Overhead Refining Total (
$/y**rl.
6.555.000 2.636.000 1.523.000 74.000 10,788,000Capital Costs’* TP13.Is____
Development $ 3,718,000 Infrastructure 3,492,000 Mine Equipment 5,246,000 Processing 11,957,000 Other 3.615.000 Total $28,028,000
Annual Replacement Capital Costs Assumed to be $0. Exploration/acquisition costs assumed to be $1 million
"Estimates based upon U.S. Bureau of Mines Cost Estimating System Handbook (Vols. 1 & 2), 1987.
value was incorporated as it would have a uniform (and likely negligible) effect in each nation. The copper mine was assumed to be developed on a grand scale, with no
expense spared and using state-of-the-art technology.
Infrastructure requirements for the hypothetical copper mine include the construction of a 100-kilometer unpaved access road and a 60-kilometer rail line for concentrate shipment. In addition, a 50-kilometer power line was included in capital costs. Preproduction stripping was assumed to be 18 million tonnes of waste material.
The deposit is mined using a conventional shovel-truck operation utilizing in-pit crushing and conveying. The mill is assumed to produce a 28 percent copper concentrate
(containing byproduct gold) using semiautogenous grinding and flotation cells. Smelting charges are assumed to be equivalent to $0.18 per pound copper.
Yearly production from the copper mine is assumed to average slightly more than 90,000 metric tons of copper in concentrate. Ore grades are assumed to decline uniformly over a 20-year period, ranging from 25 percent higher than the average reserve grade in year one to 25 percent below in year 20. Concentrates are transported 60 kilometers by rail to a port were they are transferred to a ship destined for a
toll smelter. Salient features of the hypothetical copper mine are provided in table 4.
The Financial Evaluation Model
Net returns to the corporation were estimated for the hypothetical copper and gold mine using conventional
discounted cash flow techniques. Three criteria— net
present value (NPV), internal rate of return (IRR), and the effective taxation rate— were used to compare and contrast the mining taxes in each nation. In addition, net costs per pound of copper produced and per ounce of gold produced are compared on an aftertax basis.
The calculation of discounted cash flows requires that a decision be made as to the appropriate discount rate to employ. The appropriate discount rate to be applied in corporate project evaluation is, in theory, a function of the corporate weighted-average cost of capital as well as opportunity cost of forgone investment in other areas
(assuming that the pool of available capital is not
infinite). The discount rate to be used in an analysis such as this is, therefore, intimately associated with corporate activity, creditworthiness, and to some degree, management philosophy. In this analysis, a 15 percent discount rate is assumed (albeit arbitrarily based upon the author's
TABLE 4
Hypothetical Copper Mine Characteristics
Mins P-aarametersjL Reserves Grade Mining Rate Mill Recovery Recoverable Metal 540,000,0000 metric tons 0.64 percent copper
0.012 ounces per ton gold 0.025 ounces per ton silver 16.200.000 tons ore per year 23.800.000 tons waste per year 88% Copper, 65% Gold/Silver
91,300 metric tons copper 126,400 ounces gold/year 263.000 ounces silver/year
Operating Costs* ____ ($/yg.ar)
Mining 41,524,000 Processing 33,377,000 Overhead 5,999,000 Transportation 6,065,000 Smelting/Refining 36.231f 000 Total 123,196,000 c,3p ital.-gpg.ts* Development Inf rastructure Mine Equipment Processing Other Total Totals $ 35,917,000 46.361.000 104.529.000 110.865.000 30.210.000 $ 327,882,000
Annual replacement capital costs assumed to be $4,000,000 Exploration/acquisition costs assumed to be $5,000,000
‘Estimates based upon U.S. Bureau of Mines Cost Estimating System Handbook (Vol. 1 & 2), 1987.
perception of the "industry norm” ). Appendix D presents the impact of taxation at 6, 10 and 12 percent discount rates for each of the nations examined. It is interesting to note that, although that the project NPV rises significantly a
lower discount rate, the comparative attractiveness of the six nations examined does not change.
Corporate Structure
It is assumed that the gold and copper mine are
developed by an entity incorporated in the United States and that a wholly-owned subsidiary is incorporated in the nation where mining takes place. Dividends, equal to the annual aftertax cash flow from each mine, are remitted yearly to the U.S. parent corporation from the subsidiary. The parent corporation is assumed to have no other business interests which influence U.S. tax calculations.
The flow of funds from the mine to the parent are estimated by calculating a yearly cash flow from the mine
(revenues, less costs, less royalties, less income tax) and then by deducting any dividend withholding tax. Revenues received by the parent are then subject to U.S. tax codes relevant to foreign income for corporations (including alternative minimum taxes) before a final yearly cash flow
to the parent is arrived upon. An example cash flow for each mine is presented as appendix C.
The mining subsidiary is assumed to be the sole owner
of the deposit if allowable under national law. In both
Mexico and the Philippines, domestic ownership is required, and here it was assumed that the subsidiary and a national partner participate equally in all costs and revenues.
Given this assumption, which may be heroic, no variation in tax liability or return on capital to the U.S. parent will result from national equity participation.
In Malaysia, "free equity” to the State Economic Development Corporation (SEDCO) is a common component of mineral development agreements. This minority equity
participates only in project cash flows and does not provide capital. Because capital is not provided by SEDCO, this equity was treated as a additional tax (not applied against U.S. taxes assessed) in all cash flow analyses.
In PNG, the government has the option of acquiring up to 30 percent equity in any mining project. Although the PNG government has commonly exercised this option in the past, it does participate in costs as well as revenues on an equitable basis. The adoption of the PNG government as a partner would, therefore, have no bearing on the U.S. parent's rate of return or upon its tax liability.
Financial Structure
The subsidiary company is assumed to finance the
project with 50 percent debt and 50 percent equity. Equity funds are provided by the U.S. parent corporation and all debt is assumed to be provided by a U.S. independent
financial institution at a lending rate of 15 percent. Preproduction interest is capitalized in the analysis and debt is repaid in 15 equal annual payments for the copper mine and 7 payments for the gold mine.
Ongoing capital expenditures are financed out of
project cash flows if available. When the mine experiences negative cash flows during production, funds are provided by the U.S. parent (and domestic partners if applicable) as equity owners.
All costs are assumed to remain constant in real dollars with no allowance made for inflation or exchange rate movements. Additionally, no attempt has been made to quantify potential or actual country specific risks such as inconvertibility of currency and civil unrest. Currently, all countries examined in this study allow the conversion of funds for repatriation at or near market rates. (IMF 1989)
Mine Sensitivity Analysis
The base case assumptions for mine operating and
capital costs are those provided in tables 3 and 4 for the gold and copper mine. The base case project debt was
assumed to be 50 percent. Metal prices used in all base case cash flows were $0.85 per pound for copper, $350 per
ounce for gold, and $5.25 per ounce for silver. Precious
metal prices were chosen based upon recent price levels due to the short mine life assumed, while the copper price
represents the constant 1989 dollar average of the period 1983-1988.
Given these assumptions, the hypothetical gold mine has a pretax internal rate of return (IRR) of 52.5 percent and a pretax NPV of $23.9 million. The hypothetical copper mine has a pretax IRR of 31.7 percent and a pretax NPV of $114.4 million. Both NPV's are calculated at a 15 percent discount rate as discussed previously.
Variation in the level of taxation and the distribution of project cash flow in each nation is estimated given
various capital, operating, and price sensitivities. The
contribution of debt to the project is varied from 0 percent to 75 percent in order to determine the effect of increasing debt levels on the distribution of project returns.
Chapter 3
TAXATION IN NATIONS EXAMINED
The method of taxation as well as the rate of taxation, (both published and effective), varies tremendously among
the six nations examined. In this chapter, the basic
features of tax codes in each nation modeled will be examined, the assumptions and methodology employed in
modeling these taxes will be discussed, and the results of the base case financial evaluation will be presented.
Overview
The most common tax in the six nations examined, and quite likely in all nations, is the income tax. The rate of
income tax differs among nations, although the definition of taxable income varies even more. Because the basis for any given category of tax is subject to national standards, the author will resist the temptation to average published tax rates between nations. The effective rate of taxation, as calculated from the model presented in chapter 2, will provide a more rational method of internation comparison, and is presented shortly.
It is of interest, however, to know with what frequency various taxes are applied; at least in the nations examined
in this study. The second most common tax among the group of nations examined is the royalty, which five of the six nations incorporated (table 5). Dividend withholding taxes are levied in four nations, while three nations have
substantial state, provincial, or local taxes. Mandatory employee profit sharing, as well interest withholding and minimum taxes are found in two of the six. Only one nation applies an additional profits tax.
Other points of interest are that only one nation is likely to require nonparticipatory "free equity," and that only two nations have formal provisions limiting foreign ownership.
Application of Tax Codes
New tax codes are being introduced in several of the
nations examined in this study. Commonly, these changes are
phased in gradually. Corporate taxes, for example, may be lowered 1 percent per year over a five-year period. In this analysis, all tax rates and deductions are assumed to be their final value following all announced phased changes. This assumption was made both to simplify this analysis and to slow the obsolescence of its results.
Assumptions regarding investor conduct and choices were frequently required during the application of taxes to the
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s s* 8 ex tr em e va ri at io n of ba si s fo r ca lc ul at io n be tw ee n na ti on s. So ur ce : Co mp il at io n by au th or .two hypothetical mines. The guiding criteria used in such situations was NPV: if NPV was increased by an option, that option was taken, if not, the alternative was assumed. For example, in situations where the investor is given an option to expense or amortize a given item, both methods were
tested, and that method providing the investor with the highest NPV was chosen.
For depreciation purposes, all assets were divided into four categories: mining machinery, buildings, vehicles, and other equipment. Depreciation rates applied to each class were selected based upon a review of rates applicable to various asset categories provided for under each nation's tax codes. The same initial balance for asset depreciation, amortization, and preproduction expense was applied in each nation.
The investor was assumed to send all cash flow in excess of ongoing capital requirements to the parent
corporation annually. No time lags were incorporated into this analysis, and tax regulations regarding inflationary accounting were not considered, as no escalation of costs or revenues was included in the cash flow model. Country
specific taxes and assumptions are provided in the following discussion.
Papua New Guinea
The major elements of PNG's taxation system are an income tax of 35 percent, a dividend withholding tax of 17 percent, and an additional profits tax (APT) of 35 percent
(table 6). In the base case analysis, only the gold mine
was sufficiently profitable to trigger the APT, and then only during the last year of its operation. Under the various sensitivity cases, both mines trigger the APT.
Calculation of the APT is relatively simple. In essence, the APT is triggered only when the cumulative aftertax cash flow, compounded at 20 percent or the prime rate plus 12 percent, becomes positive (20 percent was
assumed in this analysis). If the APT is triggered, it
applies only to positive aftertax cash flows derived
yearly, not to pretax income. Should any factor result in a loss, the APT is only triggered again once that loss has been absorbed by subsequent positive cash flows.
The major incentive offered by the PNG mining tax system is accelerated capital recovery, the calculation of
which is quite complex. In brief, a mine is allowed to
claim depreciation and amortization as rapidly as desired so long as it does not result in a loss, and so long as the mine's net aftertax cash flow (including any interest payment) is not greater than 25 percent of the initial
TABLE 6
Mining Tax Codes in Papua New Guinea
Allowable Foreign Ownership Industry Incentives:
Accelerated Depreciation Corporate Incone Tax:
Base Corporate Tax Bate Excess Profits Tax
Allowable Incoie Tax Deductions: Depreciation: (Standard Rate)
Mining Machinery Buildings Vehicles Other Equipient Amortization
Loss carryforward (years) Interest Other Taxes: Royalties: Dividend Withholding Interest Withholding Value-Added Taxes Employee Profit Sharing Iiport\Export
Mininun Taxes Local/State Taxes
Permitting Property Taxes
1001 Goverment has option to purchase 301.
25% Dp to 25% of all capital costs/year until aaortized; say not create a loss. 35%
351 When emulative after-tax cash flow becones positive. (201 compounding)
101 May negotiate; rates applicable
lot
to ongoing capital investaent-101 initial capital accelerated rates.
lot
25% Sinilar to accelerated depreciation.
7 Depreciation Bay not create a loss,
loot
1.25% Based on F.O.B. sale value of all metallic minerals. 171 Applicable to all dividends.
Ot Major nines exenpt. ot
ot
01 Waiver granted to najor nines. Ot
Ot Royalty shared with states.
Insignificant. Insignificant.
Sources: East-West Center, 1989, Prospects for D.S. Participation in Mining in the South
Pacific. The East-West Center, Honolulu, Hawaii; Price Waterhouse, 1985, Taxation of Mining
and Petroleum Operation in Papua Mew Guinea; Clark, A., et al., 1988, Monfuel Minerals: Status
and Policies in Selected PECC Countries. The East-West Center, Honolulu, Hawaii.; Chan, J.,
1987, Mining and Investaent Law in PMC, in Proceedings of the Pacific Ria Congress 87. Gold Coast, Australia.
capital. The calculation of the amount to be claimed is an iterative process. The result of PNG's capital recovery provisions was a four-year, income-tax-free period for both mines examined.
The Philippines
The mining taxes applied in this analysis were based on a July 1989 final draft of new Philippine mining
legislation. Under this legislation, foreign ownership is
limited to 40 percent. In the cash flow analysis, it was
assumed that the U.S. mining firm was able to locate a domestic partner for the mine and that all earnings were consolidated into the parent's income for U.S. tax purposes. This assumption is necessary, as is the factoring up of the parent's cash flow to a 100 percent basis, for internation comparison.
The key components of Philippine taxes are a 35 percent corporate income tax rate, a minimum value-based royalty of 5 percent which is divided between the state and the
government, and withholding taxes of 15 percent on interest payments and 20 percent on dividends (table 7). Royalties are negotiated on a mine-by-mine basis. The minimum
