Overdue VAT Refunds Bare Mexico’s Faulty Tax Framework

President López Obrador has vowed not to conform to the worldwide tendency of providing tax relief packages for minimizing COVID-19’s impact on businesses. The president’s hard-nosed austerity has even drawn comparisons to Ronald Reagan and Margaret Thatcher.

Mining activities have been suspended in Mexico due to the pandemic, and the industry is scrambling for alternatives to keep cashflows afloat. A source of liquidity is recoverable value added taxes (VAT). Mining is an export sector, so it normally has favorable VAT balance sheets. Nonetheless, tax authorities have unwarrantably delayed refunds. Commenting on this circumstance, CAMIMEX, the industry’s foremost association, has made the following statement: “Tax refunds are now overdue, even when many of CAMIMEX’s members are certified as highly-exporting businesses. That entitles them to receive VAT refunds within 30 days of filing. There are roughly US$1 billion in overdue refunds to the mining sector. This, in addition to the financial stress caused by the COVID-19 pandemic, has jeopardized cashflows.”

The delay in VAT refunds is a negative trend in Mexico that predates the current sanitary contingency. In fact, it dovetails with other characteristics of the Mexican fiscal framework that weaken the county’s competitiveness as a mining jurisdiction. Most burdensome among these is the protracted time period mining companies must wait for deducting pre-operating expenses. As Bernardo Ramírez, partner at Chevez, Ruiz, Zamarripa, explains in an article for Mexico Business News (MBN), “the general rule in Mexico is to deduct pre-operating expenses following a straight-line depreciation over a 10-year period. Prior to 2014, pre-operating expenses incurred by taxpayers in the mining industry were deductible through a one-time depreciation deduction in the fiscal year in which these were incurred. Currently, however, mining pre-operating expenses related to exploration of mineral deposits susceptible to exploitation are deductible under the general 10 percent rate.” Not allowing mining companies to immediately deduct pre-operating expenses betrays a lack of knowledge of the industry on the part of tax authorities. It ignores the high-risk, long-term nature of mining investments, as well as the industry’s markedly cyclical nature.

The fact is that Mexico’s tax revenue level is notoriously low. At 16.1 percent of GDP, it is the lowest across OECD members, whose average is 34.3 percent of GDP. In such a framework, the mining industry becomes an easy target for revenue-hungry governments. Nevertheless, imposing new taxes or increasing existing ones can backfire by overburdening companies and deterring investments. Alternatively, designing smart and fair fiscal frameworks has the potential to stimulate economic activity and eventually increase tax revenue. “If tax types and rates are decreased,” explains Ramírez in an interview with MBN, “the correspondingly higher volume of economic activity generates more tax revenue than before. If you look at corporate income tax rates in most European countries, none are above 25 percent. To cite an arguably comparable case of a developing country, India lowered its corporate tax rates significantly to increase its tax revenues. This is why Mexican mining companies often complain of being overtaxed. They witness these international examples and wonder why the Mexican government is not doing the same.”

The drive for imposing new fiscal burdens on mining activities has not been exclusive to Mexico’s federal government. In 2017, Zacatecas, an eminently mining state, put forward an initiative to collect a new Ecological Tax. After years of a tug-of-war between the state and the private sector, the Supreme Court finally ruled that the tax, in so far it applies to the mining sector, is unconstitutional. As reported by MVS Noticias, the Supreme Court found that Zacatecas was aiming to tax a matter that is exclusive to the federation.

Even if the tax was finally repelled, Zacatecas’ initiative set a negative precedent that dampened investor sentiment in Mexico. Mining is extremely capital intensive and significant ROI on a mining venture is usually experienced only after many years, often even decades. Therefore, what miners need is as much certainty and stability as possible. Even relatively high taxes that remain the same over long periods of time are preferable to moderate taxes that change or increase unpredictably. Mario Hernández, Head of the Tax Mining Practice at KPMG in Mexico, advocates for a certainty-boosting mechanism that has proved its worth in other mining jurisdictions. In an interview with MBN, Hernández proposes the implementation of Tax Stability Contracts in Mexico. “Already successful in Peru, these are used to guarantee miners that the government will maintain a stable tax regime during the time a company is investing in and operating a mine. I think these could be very beneficial to foster investment in the country,” he says.