Costly business - investing in overseas mining

Materials World magazine
,
3 Jul 2011
Exploration in developing countries

The balance between securing a good deal and pricing yourself out of the market is a delicate one. Michael Forrest reports on a masterclass held in London, UK, that outlines the main considerations for mining companies when investing abroad.

Mining companies and governments have similar objectives, but from different perspectives. The company wants to maximise returns for shareholders while governments want to receive the maximum reward for the depletion of their natural resources. The compromise is reached over the level of taxation paid by firms to governments. It is often the greatest source of foreign exchange in developing countries and, at the same time, encourages inward investment. This balance, however, has been disturbed by the ongoing high commodity prices, reflecting demand, mining costs and the relative currency values.

All of these factors were the subject of a masterclass organised by local IOM3 society MinSouth, in association with the London Association of Mining Analysts and international law firm, Simmons and Simmons LLP.

Revenue generation

The relative attractiveness of a location for mining is dependent on a number of factors, according to Andrew Gavan, Partner in tax, merger and acquisition at KPMG. ‘Some countries are better than others and that depends on the state of the economy of the host country,’ says Gavan.

Industrialised economies embrace multinational companies and outward investment. They focus on transfer pricing within an organisation, and work within an established, wide treaty network. Emerging countries wish to keep their natural resource revenue to assist their development and accordingly place restrictions on foreign ownership, employ exchange controls and have high withholding taxes. They need this revenue to build infrastructure and to maintain and develop government.

‘These countries wish to retain as much value of their mined resources (and depleting reserves) as possible, and often there is a high expectation of increasing revenue from new mining operations,’ noted Gavan.

Tax dilemma

Taxes are ubiquitous, and can be classified into several business functions. For example, customs duties relate to the movement of goods, consumption taxes include VAT, income taxes, national insurance, and corporate tax relate to income, while capital gains, stamp duty and estate taxes relate to assets a company might hold.

‘Countries talk to each other and devise taxation regimes to maximise their income, but these do not always result in a stable investment climate that encourages development,’ Gavan outlined.

There are many examples of where high taxes have resulted in a lack of investment or a counter political movement. The ultimate sanction for the mining company is to withdraw and invest elsewhere. KPMG has reviewed the taxation rates globally and identified those countries that choose to maintain high rates on mining companies:

This disparity reflects the view of the host nation on what is the most appropriate, however it is the overall rate that has an impact.

‘Some countries offer incentives for investment, for example Canada offers tax credits for exploration, and Zambia 100% capital allowance. The industry wants stability and a regime that allows future planning,’ said Gavan.

But regardless, ‘Taxes are unavoidable,’ noted Chris Morgan, Managing Director of Jordan Energy and Mining, ‘and planning for them is essential for a successful project’. In a medium-size copper mine, operating costs are 44%, capital costs 20% and loan costs two per cent – the remaining 34% is split equally between profit, taxes and fees, giving an effective tax rate of 50%. On this basis, the company can plan for the future. However, over time events alter this position.

Adapting to change

From a government perspective the charges for water, power and transport may have to rise, there will be pressure to maximise local employment, and the legal and financial framework may change to meet both internal and external pressures. For shareholders, market restrictions, accounting practices, and bank requirements, such as debt financing costs, will affect their investment, while rising global prices may bring the spectre of a windfall tax. Regional stability and uncertain economic future will also impact.

‘Planning for these events is not always possible,’ observed Morgan, ‘but the first step is to ensure your negotiations with the government cover as many factors as possible. The current mining law will set some parameters, but others can be negotiated.’ Companies require clear title, satisfactory fiscal, legal and environmental regimes, and the right to move product and profit out of the country.

A fully transparent corporate framework, and the right to international arbitration, are also required. The objective is equanimity, where each party is content with the negotiated deal under changing circumstances. One prominent change over the past few years has been the rise in commodity prices. Governments see incomes rise and, on that basis, require a greater slice of the profit.

And it is not just developing countries. Australia recently had a debate on corporation taxes that resulted in intense lobbying by the mining sector and a reduction in the proposed rate.

The Jordanian government has put in place a sliding scale of royalties and tax that reflects the price of crude oil. For example, when Brent Crude drops below US$60bbl, royalties decline to one per cent from five per cent. Tax is also calculated on a sliding scale according to a formula that rises from 15% to 65%. To satisfy all stakeholders, a tax regime should be stable, internationally competitive and provide equitable distribution of proceeds under price and profit fluctuations.

Under the table

In addition to planning for taxation, mining companies must now be aware of the all-encompassing UK Bribery Act. It applies to companies whose business is located in the UK, although most of its business may be overseas, often in developing countries. It also applies to subsidiaries of foreign companies based in the UK where significant autonomy is practiced.

There has been much discussion on what constitutes bribery and what defence can be cited. Nick Benwell and Claire McCleod, lawyers at Simmons and Simmons, London, UK, outlined the guidance on the Act. ‘The emphasis is on proportionality and a risk-based approach. It acknowledges that a low risk may justify no action and it is less prescriptive that the draft legislation,’ said Benwell.

However, a corporate offence is the failure of that organisation to prevent bribery by another, where the ‘another’ is performing a service for the organisation. The company will have a defence if it can prove that it had adequate procedures in place to prevent the bribery. The Act is not designed to make hospitality an offence, says the UK’s Secretary of State for Justice, Ken Clarke, in the foreword of the advice. ‘No-one wants to stop firms getting to know their clients by taking them to events like Wimbledon or the Grand Prix.’

However, the personal enrichment of officials is prohibited, and the elimination of facilitation payments is a long-term objective of the Act. ‘Doing nothing about the Act is not an option, but the guidance recognises the difficulty of addressing some of these issues overnight,’ said Benwell.

Further information

Presentations from the masterclass will be available at www.minsouth.org.uk