Alberto Orozco
Exploration Manager
Argonaut Gold
Armando Ortega
VP of New Gold and Director General
MSX
/
Insight

Introducing a Mining Royalty

Mon, 10/21/2013 - 12:41

The Mexican government is currently poised to make a critical decision over the proposed new mining royalty, which will be charged to mining companies on top of regular income tax (ISR) and other duties that apply to all companies that operate in the country. In Mexico mining means big business, with the industry generating US$22.5 billion in 2012. The many opportunities available for mining companies to be successful in the country, combined with the absence of a royalty or production tax, has made the country an attractive investment destination. Despite some debate both within the government and the industry over the potential introduction of such a tax for some time, the Chamber of Deputies approved the notion in April 2013, with the formal proposal to amend the law being made to Congress in September 2013. It is now likely that a mining royalty tax will be introduced in the coming months. According to the Ministry of Finance and Public Credit (SHCP), mining companies will pay around MX$4.2 billion (US$333 million) in additional taxes each year as a consequence of the new royalty tax. During 2012, the mining industry contributed MX$22.26 billion (US$1.76 billion) in ISR, meaning that the additional royalty might represent a 19% increase in the tax burden for mining companies, according to fiscal experts.

How the royalty tax will work in practice is still unclear. It is not yet known whether the royalty tax will be a flat rate across all minerals, or whether it will vary according to mineral type, though it has been suggested that a higher rate of 8% may be applied to gold, silver, and platinum, compared to the standard rate of 7.5%. It is almost certain that one rate will apply throughout the country, unlike in Canada where each state administers its own royalty charge, ranging from 10 to 17%. One of the reasons for introducing the tax is to ensure that mining activities benefit the communities based near mining locations. 70% of the collected tax revenue is expected to go to state and local government, with 30% going to the federal government, though different splits have been talked about and little has been revealed about what the final amount will be. While the mining industry mostly appears to be resigned to the royalty being passed, there is some concern over the many questions that remain unanswered. “If the royalty is implemented there should at least be a clear set of rules regarding how that reduction will be made. There must be a clear pathway for that money to make it back to the community. We want transparency,” says Alberto Orozco, Mexico Exploration Manager of Argonaut Gold.

Much opposition has been voiced from different areas of the mining industry since news of the tax emerged; while original predictions placed the tax at 5%, there was some shock in September when it emerged that the amount being proposed to Congress was 7.5%. The opposition coming from the mining industry centers around two main arguments: firstly, that the industry already makes a significant contribution through CSR programs that address health, social, and environmental issues, and secondly, that the tax is coming at a bad time given uncertainty in the industry in the face of a global recession and the drop in metal prices. “We also want the government to take into consideration the fact that the mining industry is cyclical and that there has recently been a sharp drop in the gold price. At some point in the future costs will be much lower and the mining market will be depressed,” adds Orozco. “Mining will not disappear but investment will decrease. The government needs to take into consideration that a huge amount of money is invested in exploration that never reaches the exploitation phase, and that mining companies also improve the economy by bringing work to isolated regions.”

Provided that the tax is implemented in the right way, however, there could be certain benefits for the industry. For example, the royalty would have the added benefit of aligning the interests of the municipal and state authorities many of which do not always see the benefits of mining works being undertaken in their jurisdictions. The overall feeling is that there must be extreme caution around implementing any such royalty, and that the funds must be sure to continue to benefit the local communities in the same way that existing social contracts between mining companies and communities have done, as well as remain visible and not be swallowed up by other state funding needs.

In the face of these two issues mining companies argue that this royalty tax could damage the years many of them have spent building their relations with the communities and starting up successful CSR projects. This is where the question of transparency comes into play; mining companies are looking for confirmation that the solid relationships they have built with the communities will remain strong, and want to know that it will still be clear to them the money is coming from the mining industry. “We mining companies are ready to continue making contributions to the economy, but with a tax regime that provides certainty for current and future investments,” says Armando Ortega, VP of New Gold and Director General of MSX.

"The royalty could have a negative impact on investment and job creation in regions where no other economic activities are viable. Our mining industry does not have the same fiscal stimulus or tax stability as Argentina, Brazil, Chile and Peru, which are our competitors. This latter point should be taken into account to balance the current reform proposal." Humberto Gutiérrez Olvera, President of Camimex

"The royalty tax will increase production costs for the mining industry. However, if the metal prices continue to be as high, Mexico’s competitiveness as a destination for exploration investment will not be significantly affected." Pablo Méndez Alvídrez, Partner at Bensojo, Chávez y Gutiérrez

"Most mining companies are already giving a percentage similar to the one being considered for the royalty tax to local communities through their CSR programs. As a government entity, we have to be very careful to ensure that the collected revenue is used properly. We need to ensure that the royalty is invested in the municipalities where the mining companies operate and inform the local communities that the money is coming from them, so that people identify with the industry and support it."  José Armando Córdoba Hage, Dirección General de Minas Sonora

"The problem with potentially approving such a tax or royalty is that it will remain in place even when metal prices go down. This will not be a positive thing for Mexico, given that Peru and Chile are very competitive markets and could succeed in drawing investment away from this country."  Abdón Hernández Esparza, President of the Legislative Commission at Camimex

"We support the royalty tax not because it will be a bigger financial burden for mining companies, but because it is a tax that will be focused on improving local infrastructure and regional development. It is a way of mitigating the industry’s environmental impact." Álvaro Navarro Garate, Economy Minister of Chihuahua

"The royalty tax is an additional cost that mining companies need to take into account. One thing to take into consideration is that profits do not usually flow to the owners, because a large proportion of them are reinvested in exploration. Restricting the ability of companies to invest in exploration and development will affect the entire industry today and in the future." César Garza, Parner at Deloitte

"There is never a right moment to tax any industry, anywhere. The government is late in introducing this tax. After hearing about the mining boom for years, they inconveniently decided to do it when the prices are declining and exploration companies are struggling to find funds. The real problem with any new tax is that it affects the marginal producers; this is the technical detail we really have to analyze." Mauricio E. Candiani Galaz, President & CEO of Candiani Mining

"Mexico has to focus on continuing to be an attractive market, not only for foreign investment but for national investment as well, by providing fiscal stimuli and other incentives. The government cannot afford to lose perspective of the fact that if companies do not have enough money to spend the economy will be stalled. Communities located in remote locations thrive when a mining company begins operations, bringing direct and immediate benefits." Brenda Carranza, General Manager and Global Marketing Manager of Falcon Drilling