A regressive approach to the mining fiscal regime

Dindo Manhit, President of the Stratbase ADR Institute

Eight months since the first phase of the Tax Reform for Acceleration and Inclusion (TRAIN) Law was implemented, inflation hit a near-decade-high 6.4%, well beyond government forecasts and, more crucially, something that may upend years’ worth of significant economic growth.

While the administration’s ambitious infrastructure agenda is long overdue and surely worth the investment, tinkering with something as sweeping and overarching as taxation demands care and meticulous attention to its effects as we have seen with TRAIN.

The second phase of the tax package is looking to generate the same level of controversy, if not more. Barely ten months ago, TRAIN 1 doubled the excise tax on mining from 2% to 4%. A specific mining tax reform bill, filed in the House of Representatives and backed by the Department of Finance, proposes a 5% royalty for all large-scale and small-scale metal and non-metal operations regardless of whether they are located within or outside mineral reservations.

While retaining the corporate income tax for mining, the bill also requires an additional government share of the difference when the basic government share is less than 50% of the net mining revenue for the calendar year. It also proposes to limit interest expense deductions of mining contractors, for instance, if the contractor has a debt-to-equity ratio higher than 1.5 to 1 at any time during the taxable year.

The proposal’s claimed intent is to “satisfy the objectives of government for a reasonable increased share without compromising the mining sector’s need for a reasonable return on its investment.”

What is not said, of course, is that the imposition of the additional 5% royalty, on top of the various other charges on gross revenues, would make the total impositions on gross revenues the highest in the world at close to 12% all in all.

Contrary to the said intentions, the proposal runs the risk of making the sector even more uncompetitive in terms of attracting quality investments. As the mining industry demands intensive capital and sophisticated technology, it requires nothing less than quality investments. This means large, responsible companies with a lot of resources, technical know-how, and experience.

Already, the regulatory environment in the Philippines is far from agreeable. A prohibitive tax structure threatens to drive out badly needed investments to other mineralized countries that have more sensible tax structures.

A 2012 study by the International Monetary Fund (IMF)found that a 10% royalty in the mining and petroleum sector is, by international standards, “quite high.” For a market like the Philippines, attracting investments in its mining sector largely depends on how well it can manage its fiscal regime.

Another important detail that the bill seemingly glosses over in favor of so-called rationalization is the critical distinction between copper and gold operations, on one hand, and nickel operations, on the other.

According to industry experts, the former requires much higher investment in mine development, such as in the construction of a copper concentrator or a gold-processing plant. The gestation period is also longer, from exploration to commercial operations, at an average of 15 years compared to 4 years for large lateritic nickel mines. The larger scale of operations for gold and copper also means it is more difficult to absorb the royalty during periods of low prices or when the operation is not profitable.

Thus, despite the lip service on supposedly looking after the mining industry’s welfare, the bill’s combined impositions on gross revenues, payable whether a company makes money or not, would no doubt discourage new quality investments in copper and gold mines, not to mention make it very difficult for existing operations to survive.

Crunching the numbers, the bill’s proposed “top-up” of up to 50% of net mining revenues makes the structure virtually equivalent to a Financial and Technical Assistance Agreement, which is deemed uncompetitive internationally by the IMF study.

But if the impositions of this bill are poised to sound the death knell for the industry, the other elements in the Tax Reform for Attracting Better and High-Quality Opportunities (TRABAHO) bill, promise to be the proverbial final nail in the coffin. TRABAHO repeals incentives available to the industry under the Mining Act of 1995. This means that if the mining industry is not included in the proposed Strategic Investment Priorities Plan, the sector will be ineligible for any incentive whatsoever.

What all these amount to is a regressive — not progressive — tax structure. Compare these provisions, for instance, with the model in Chile, the top copper producer in the world. Chile has a mining tax that is applied to profits at a rate that depends on operating margins (6.65% at a margin of 50%). Peru, the second top producer of copper, implements a similar royalty system that is applicable to profits (3.64% at a margin of 50%).

What makes these models progressive is how they’re skewed toward profitability, with higher tax rates depending on operating margins. This sharply contrasts with high impositions on gross revenues that completely ignores the profitability of an operation. The message the proposed mining tax reform bill sends to both existing and potential investors are thus self-evident.

But will mining really stop if the large, responsible miners are out of the picture? Only to a certain extent. Killing the legitimate players will only create a vacuum that will open the country’s vast untapped mineral resources to illegal operations. This scenario not only squanders billions of dollars in potential revenues and hundreds of thousands of quality jobs, it also subjects hundreds of areas to irreversible environmental destruction, all of which does not make any sense for a bill that calls itself progressive.

The proponents of this regressive policy must realize that crushing an already highly regulated industry whose huge economic potential is globally recognized, but has been frustratingly stymied with decades of unstable policy, will send stay away signals to large investors of other industries. The job-creating industries that we want to build will look for less volatile business environments and there are many alternatives out there.

 

 

Image Source: BusinessWorld

 

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