How the Chilean Mining Royalty will Impact the Industry
On July 1st, 2022, Chile’s finance minister, Mario Marcel, introduced a tax reform bill that could increase copper mining royalties in Chile.
The new bill has been controversial due to what many say will make the Chilean mining sector uncompetitive with its peers. On the other hand, the government says it will not affect investment and is key to financing the governments proposed social programs.
As with any tax reform, it needs to be evaluated thoroughly to understand the true effects. We have provided a high-level assessment to help you understand in more detail how the increase to the mining royalty will impact the industry.
Why increase the mining royalty?
The government introduced the tax reform bill with proposed increases to the mining royalty as part of a larger bill that aims to fund social programs such as health care and pensions. Ultimately, the reform is meant to increase tax collections by 4.3% of GDP when fully implemented.
What are the proposed changes to the mining royalty?
The royalty has two components –
The ad valorem is applied progressively to annual sales of fine copper, with effective rates of 1% to 2% for mining companies that sell more than 50,000 metric tons of fine copper (TMCF) per year but less than 200,000 tons.
For companies who sell more than 200,000 tons, it will have a marginal rate of between 1% to 7% depending on the average annual price. When prices are between US$2 and US$3, miners will pay 4%. When prices are above the US$3, then 7% is paid.
Producers of more than 50,000 metric tons of fine copper will also be subject to the second component on the mining margin, applied to the adjusted mining operating taxable income, with rates between 2% and 36%. Priced between $3.25 and $4.25, the effective rate may not exceed 20%, says the project.
What is the opinion of experts on the proposed royalty?
All sectors of the mining industry have come out against the new royalty saying that it will be determinantal to the industry for a variety of reasons.
“The Mining Royalty is not viable for the development of national mining, on the contrary. For this reason, we propose that the Specific Mining Tax (IEM) be modified, with which we are sure the collection will be greater and without jeopardizing the investment and continuity of operations in the sector,” said Miguel Zauschkevich Domeyko, President of the Mining Chamber of Chile.
Fitch Ratings stated the following “The tax reform package proposed by Chilean President Gabriel Boric on July 1 includes higher taxes for copper producers that would increase costs and weaken the sector’s competitive cost position, relative to global peers”
BHP stated the following “We have serious concerns with regards to the new royalties,” the company said. “If the proposed royalty (hike) materializes, we would have to reevaluate our investment plans for Chile.”
What are the specific grievances with the proposed royalty?
For a new royalty to be successful, experts agree that it needs to meet at least four conditions: It does not affect the competitiveness of the Chilean mining sector; considers the differences in production costs; contemplate some stability mechanism for investors; tax revenues generated must be destined to the mining regions.
Unfortunately, it is widely agreed that the new tax reform only accomplishes one of these conditions which is that tax revenues generated will be destined to mining regions.
The two main grievances are the following –
It does not affect the competitiveness of the Chilean mining sector
According to a research report released by CRU Group last week, the new royalty would raise the average effective tax rate for large mines to 50% in 2024 and to an average of 59% for the period 2024-2040. In comparison, Canada has an average effective tax rate of 40%, Australia is 41%, and Peru is 39%.
Miners have an average effective tax rate 37% under the current regime and 43% under a proposal previously presented in Congress.
Clearly, the new royalty pushes Chile way above its peer in terms of taxation. The government argue that the demand for copper means investors will still invest regardless of the royalty, but the reality is that investment into future copper production will flow first into lower tax countries first. Only when all those opportunities are exhausted will they look at higher tax jurisdictions.
The result is new projects in Chile will most likely be delayed and the country could miss out on increasing production
Considers the differences in production costs
In addition to the average taxation companies would pay, the new royalty completely ignores the fact that each mine has its own cost structure.
The ad valorem tax is not based on the company’s profits, but instead on gross sales, which does not consider that operational costs are different between operating mines.
An ad valorem tax is easy for the tax authorities to manage and calculate since it is directly based on the price of copper, but it leaves high-cost producers exposed when prices are low.
It is important to remember that the Chilean mining industry is already facing higher costs due to having to dig deeper, lack of water, and lower ore grades. In addition, companies are making capital intensive investments in technology, machinery, and people which all result in higher costs.
All of the above is putting pressure on margins and could put mining companies into negative cashflow in a low-price environment if they need to pay taxes on the top line revenues.
It is no secret that the Chilean tax collection rate of 20.7% of GDP, is well below the OECD median of 34.7%. The problem is not whether the mining industry is paying its fair share. Instead, the industry is being used to raise money in the quickest way possible which ultimately will have long term consequences on the industry.
The proposed mining royalty fails the mining industry who has been a major pillar in the Chilean economy for more than 30 years. It ignores the fact the industry already contributes a significant amount of direct and in-direct jobs. The jobs created by the mining industry tend to pay more than any other sector which is also taxed. We have not even started talking about new industries that are now taking off in Chile partly due to the ecosystem that the mining industry helps to create.
Would the solar and wind industry in Chile be as developed today without off takers such as the mining industry? What about companies that have gained from having a robust local mining industry that are now exporting equipment, technology, and services to other countries? These are all areas that have grown considerably over the last 10 years in Chile, which is attracting even more foreign investment money to the country, creating more employment opportunities, and therefore creating even more revenue for the government to fund social programs.
There is room to raise the royalties which mining companies are willing to pay, but it must be competitive from a global perspective and reflect the realities of the industry where unfortunately costs are increasing. Anything less than that means that we are failing future generations who will not benefit from a robust mining industry and the tax revenues it generates both directly and indirectly.
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