Tax Policy at a Crossroads

Q: Why is the basis upon which the mining fund tax is calculated technically deficient?

A: It is technically deficient because operations of mining companies can be fully integrated and cover everything from extraction to the capitalization of the metal benefits. However, the value of their operations is tied exclusively to their extraction activities. If a company is integrated beyond these operations, then the value created by those separate activities will still be assigned to extraction. There are no clear rules on how companies should identify and separate the value generated through extraction. Some companies are part of conglomerates but they are structured according to some previous division that allows them to allocate risk separately and thus separate this value. These conglomerates will divide a project’s operations into different companies in charge of categories such as personnel, land ownership or supply of technology and specialized equipment. Technically, only one company will be in charge of extraction, so when it comes time to tax the value of extraction the value is fragmented and not easy to track. This is why a new basis is necessary to identify what truly is the value of a concession and establish what activities are taxable. Without this basis, companies can be overtaxed or undertaxed. Integrated companies can be overtaxed because they are paying an extraction tax on business unrelated to extraction, and fragmented conglomerates can be undertaxed because the tax will be based on the value of the extraction company. Different metrics are needed. Mining companies sometimes complain that the government does not understand the industry’s inner functioning. A degree of expertise is needed to identify these patterns and legislate accordingly.

Q: How can a balance be achieved between the government’s fiscal policies and industry growth with fewer obstructions?

A: The government will always find ways to increase tax revenues. This can be done by increasing the number of types of taxes and their respective rates. Finding new forms of economic activity to tax within old and new industries is common. However, this assumption proves false when you compare Mexico to other countries. If tax types and rates are decreased, 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; the corporate income tax rate in the US is 21 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.

Q: In 2019, “universal compensation” was eliminated from Mexico’s tax code. What does this mean for the average mining company?

A: In general, mining companies need capital investments. Once mineral extraction potential has been established, upfront investments are necessary to purchase the assets and build the infrastructure needed. When these investments are taking place before production and corresponding revenue can enter a mining project’s plan, a significant part of the budget is spent on the value-added tax of asset purchases. If under the same corporate tax umbrella there is a mining project or company that is in this initial phase, and another one that is in its advanced producing phase, you apply value-added tax paid on the first project to offset the corporate taxes of the second project already generating revenue. This was enabled by universal compensation. With this resource eliminated, the hypothetical company is now stuck paying both types of taxes separately. This system interferes with growth through production capacity and it costs mining companies 16 percent more to build new facilities. It is a vision with short-term benefits, but it is not unconstitutional, so companies cannot protect themselves against it. The inevitable results we have witnessed so far from companies in the sector is that they are investing less.

Q: Why is it so difficult for mining companies in Mexico to deduct investment expenses?

A: There have been some recent changes regarding how mining companies can deduct investment expenses, such as exploration costs. Deduction periods have been extended and for miners, that can be a burden because you can spend a significant amount of time in exploration activities, searching for success, and these expenses add up very quickly. The new rules state that once activities are productive, the taxpayer absorbs these expenses over larger periods of time. That is one negative impact. Another is that different and less common types of investments make enforcing existing laws a little complicated even for the authorities. I am talking about investments in assets that get interpreted by the law as permanent constructions but are instead considered temporary elements of mining infrastructure. Reaching a zone of mineral extraction can involve a sequence of events composed of building types of structures that are destroyed so that other structures can be built in their place. These structures cannot be fiscally thought of as constructions, buildings or permanent facilities. They may last up to one, two or even three years, but they were not built for anything other than granting temporary access to minerals, while a larger and sturdier structure could be built in its place. This is very confusing to the authorities, who choose to account for it as a permanent construction instead, but this is not the case at all. In other words, all I did was move dirt around and fix it in place with concrete so that I could work without an entire hill caving in. It is a hole that has been dug but nothing was “built.” This confusion has caused a lot of headaches for both the authorities and taxpayers. What taxpayers see as temporary investments to be accounted for in one fiscal period, the authorities choose to see as permanent assets to be accounted for over six to 20 years. This represents an enormous monetary difference. These changes began with the previous presidential administration.

Q: What other important changes in tax policy has the present administration implemented or is considering?

A: An important change limits the possibility of earning and using tax credits toward paying of IEPS (Special Tax on Production and Services) with the import and purchase of diesel fuel. This is now only available to the transportation of goods and passenger sector. Mining companies no longer have access to this option due to the high volume of diesel employed in powering the sector’s specialized machinery and technical equipment. This is almost a tax on a tax. It has an undeniable impact that represents multimillion-dollar expenses for mining companies in Mexico. Another important change is the application of preferential tax rates for border regions. There are technical deficiencies in the application of these rates that must be addressed. If you read about these reduced rates, it would seem like they are designed for the smallest of companies; however, that is not how the rulebook is being put together. This situation is creating gaps in the way in which these rates will apply to the biggest players in the market, particularly mining companies.

Considering this situation, the government made a commitment to make no major structural changes to Mexico’s tax regime, and they have so far held themselves accountable to that commitment. While last year there were changes, none of them introduced a new type of tax or significantly modified the application of existing laws. I do not know what the administration is planning to do; nevertheless, precedents are being set at a statewide level that might eventually influence federal decisions. An example could be the Zacatecas environmental tax, which the right for the State to impose ecological taxes, was recently upheld by the Supreme Court, although not the taxes approved so far, and that needs to be resolver on a case by case basis. It makes sense that the mining industry would return a significant part of the value it generates back to the municipalities that surround its activities. For this reason, the Mining Fund and its structure of fund allocation is a perfectly logical idea; however, just like this environmental tax, it adds another tax at a statewide level that means you still are taxing the industry more, and as you tax the industry more, you will continue to slow down its growth and decrease tax revenue.