Mario Arregoytia
Lead Partner for Mining and Metals for Mexico and Central Amerca
EY
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View from the Top

The Six Pillars of Cash Optimization

Wed, 10/19/2016 - 11:36

Q: How does EY perceive the point of contention between the reform and exploration activities subjected to taxation?

A: The restrictions on exploration deductions have exacerbated the crisis within the mining industry. The dilemma mainly derives from a drop in metal prices, and the fall of the Chinese economy. For the same reason royalty fees have not spawned as much revenue as expected, and Mexico has fallen behind Chile and Peru in terms of foreign investment for exploration. Mining companies were allowed to deduct 100 percent of the exploration expenses incurred in the year before 2014. Today, such expenses are considered depreciable and only 10 percent can be deducted annually.

Not only does the reform stipulate conditions that demotivate foreign investment in exploration but it also creates contradictions since the tax treatment only applies to “new deposits”, a term that is reasonably difficult to define when dealing with mineral resources. The fact that the Mexican oil industry is allowed to deduct 100 percent of its exploration expenses equally highlights disparity among industrial conditions. Mexico lags in the international race to attract investment because many other mining countries promote foreign participation by granting tax incentives for exploration expenses. In my opinion it is a shame that Mexico took a different path in the 2014 fiscal reform.

Q: How is the complex web of regulation and tax obligations evolving in Mexico, and in what ways can EY contribute?

A: The company is witnessing an incoming wave of clients that have a great deal of questions related to the application of new royalty fees and deductions for exploration expenses. Fortunately, Mexican tax authorities are improving their audit processes and will soon be optimizing royalty tax audits and the classification of expenses for tax purposes. EY helps clients comply with regulations and obligations through an array of services that include accounting, legal, regulatory, tax, litigation, advisory, and audit.

Q: How is the lack of exploration impacting the industry, and what must the government do to attract more foreign investment and make Mexico more competitive in the international market?

A: The financial impact it has upon mining companies is important. An annual 10 percent deduction of exploration expenses implies that companies have to wait 10 years to recover their investment, which in turn means there is less cash available to continue exploration and extraction activities. The Mexican government should reinforce public policies related to the mining sector and listen to actors within the industry, including the Mining Chamber, that are requesting a change in the tax framework applicable to mining companies.

Q: What can mining companies do to overcome the stagnant metals prices?

A: Cash optimization, through the generation and preservation of capital, is indispensable for mining companies that are struggling to stay afloat in the stagnant market. Companies should focus on the following six pillars to assure a solid foundation of effective cost management, cash release, and balance sheets positioned for future growth. First on the list is cost reduction, a measure that demands a balance between sustainability and activities that protect against value erosion. Working capital is second as it is the single biggest area for gains to be made with the support of processes and systems across the supply chain, particularly spare part inventories. The third pillar involves a systematic and integrated endto-end approach to productivity that can drive significant improvements via asset rationalization, labor productivity, material consumption, and cash deferrals. Capital effectiveness is the fourth element as a program built on the back of efficient asset management can provide solid foundations for productivity and risk management. Moreover, evidence shows that efficient portfolio strategies can be achieved by holding assets within the portfolio that have different levels of risk, return, and correlation, which achieve an optimal return with an equal or lower level of risk for the same rate. Finally, the financing pillar incorporates various capital release strategies to pay debt.