CHILE LAWYER: ROYALTY BILL UNLIKELY TO PROSPER TODAY, BUT PROBABLE IN MID-TERM

High copper prices have intensified the discussion as to whether to make Chile's mining royalty laws more aggressive.

Days after the finance commission in Chile’s lower house gave a negative vote, the house plenary went on to approve a 2018 bill proposing changes to the mining tax introduced in 2005.
Nevertheless, there are many constitutional hurdles that will most likely prevent this bill from becoming law, according to Rony Zimerman, natural resources sector expert at Chilean law firm Lembeye.
One of the constitutional hurdles is the fact that this can be seen as a new tax, and taxes require a presidential initiative whereas this was a parliamentary initiative, Zimerman added.
The country is preparing for a ground-breaking initiative to rewrite the constitution, amid longstanding public pressure to change the constitutional rules regarding mining, but there are many competing ideas about which changes are best.
Now, with the timing of this high-profile royalty bill it’s likely that some of the amendments will aim in this direction. Zimerman states that a true royalty may indeed require a new constitution, but a tax that mimics such a royalty could still be introduced without a constitutional change.
«A bill establishing a higher tax on mining can be drafted within the existing constitution, perhaps by a future center-left government. There is growing popular support for such a measure,» he said, adding that although the current bill probably won’t prosper, this congressional effort is an important shot across the bow that shows that a battle over this issue is at hand.
«Either via a traditional mining royalty, higher industry taxes or higher annual mine license fees («patentes») – it’s likely that mining and exploration projects are going to pay higher rates in the mid-term,» he concluded.
The 2018 bill proposes that mining firms should be taxed at 3% of the market value of the copper (and lithium) they produce, and that firms producing less than 12,000t/yr should also be included.

Lembeye law firm's natural resources specialist, Rony Zimerman

This would represent a major change from the 2005 royalty law, which applies a variable rate to operating profits – ranging from 5% to 14% – depending on the tonnage of metal produced. There is one set of rates for firms producing up to 50,000 tonnes per year and another set for those producing more than 50,000 tonnes, while firms producing less than 12,000 tonnes per year are exempt.
The mining tax comes on top of the statutory tax of 27% that all businesses pay on earnings up to 17,000UF (US$615,895 today). However, the 2018 bill came about because many assert that the mining lobby succeeded in weakening the 2005 law at that time.

Better a tax on processed metal rather than profits?

SOLID ARGUMENTS FROM THE INDUSTRY

In rejecting the bill just before the lower house passed it, the finance commission in effect agreed with the mining lobby’s argument that firms’ margins are already under great pressure due to taxation, and that a change in the laws could be damaging to Chile’s reputation for stability.
One could argue that no such damage occurred in 2005, but Zimerman notes that the super-cycle in those days was an entirely different animal compared to the current price boom.
«It’s understandable that in the context of the social unrest and constitutional debate, many look to see if mining projects can make a bigger contribution to Chilean society – especially when they see the rise in the market prices.  But this public fervour needs to be tempered by an understanding of current industry factors that could cool investments such, as declines in copper grades in places and social instability – these, along with a change in the investment structure could affect the enthusiasm to invest,» the lawyer said.

This congressional effort is an important shot across the bow that shows that a battle over this issue is at hand.

Relative independents in the business world, such as economist Tomás Flores of the Libertad y Desarrollo thinktank and Sofofa vicepresident Susana Jiménez, have also weighed in with support for the industry, stressing that mining-specific taxes in Chile are second only to those in Australia, and in this respect the two countries form a unique sub-group with taxes far in excess of other mining economies around the world.
Jiménez also notes that in the Fraser Institute’s annual survey of mining firms, Chile was ranked the 30th most attractive territory in 2020, having peaked at sixth place in 2018.

Proportion of active vs inactive exploration firms in Chile Source: Cochilco, Oct 2020

DIVISIONS IN THE PRO-ROYALTY CAMP

The 2005 royalty was inspired by a copper price super-cycle that started in 2003, and conveniently allowed the country to amass funds that protected it during the 2008 financial crisis. Despite that positive outcome, criticism that the 2005 law change didn’t go far enough has remained constant over the years, and even those behind the 2018 bill could not have foreseen the severity of the pandemic or even of the social unrest that exploded in October 2019 (and whose negative effects are arguably still at work, although masked by the pandemic).
Consequently, there have been calls to go a step further than merely taxing production instead of profit.
Prospective presidential candidate Ignacio Briones (a board member of Codelco and, until January 2021, President Sebastian Piñera’s Finance Minister) recently reiterated a longstanding proposal that rather than alter the mining tax, Chile should  mineral exploitation licenses. 

This would emulate the structure used in Australia, Canada, USA and Peru, and could more than double the money that the tax brings in, he estimates.
At US$1.4/ha for exploration and US$7/ha for mining, Chilean licenses are some of the cheapest among the world’s mining-dependent economies, with a 100ha exploration license going for US$148 compared to US$6,552 and US$5,951 in the US and Peru, respectively.
This relatively low cost and the licenses’ unlimited validity allows majors to easily accumulate them for future use, and as a result they tend to lie idle for long periods.
A higher cost of licenses could therefore act as an incentive to either put them to work and get a return on that investment, or sell them on to firms that are more able to do so.

Copper super-cycle 2005-2008 Source: Enzo Napoli and Patricio Navia, 2009

BACKGROUND TO THE 2005 TAX

While Chile’s dependence on copper goes back many decades, and has always had a strong element of foreign investment, a number of events in 2002-2003 galvanized the discussion of how much the country was losing out to these overseas players in financial terms.
Firstly, Exxon Mobil Minerals was able to sell its Disputada property to Anglo American for US$1.3bn without paying any kind of capital gains tax in Chile, thanks to its argument that the deal was between two foreign companies.
Secondly, after some six years of declining copper prices, the metal started gaining ground in 2003, culminating in explosive growth at the end of the year.
Parallel to this, the mining industry’s contribution to Chile’s GDP doubled from 7% in 2000 to 13.4% in 2004, with no sign of letting up.

Thus, discussion of a royalty was feverish in 2003 and 2004, and finally led to changes in the general income tax law and foreign investment law. The result, passed in June 2005, was the «Specific tax on Mining».The above graph shows that the mining tax came just in time to capitalize on further increases in the copper price.
The tax came to represent 34% of fiscal revenue in 2006, when copper mining truly dominated Chile’s economy, but in absolute terms revenue from this tax peaked in 2012 at US$626mn.
At this point, other sectors had recovered from the 2008 crisis, squeezing copper’s contribution to less than 20% of fiscal revenue. Finally, falling copper prices in subsequent years, coupled with the 2019 social unrest and the pandemic, meant that the tax contributed only 5.9% of fiscal revenue in 2020.

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