Independent Report for the Australia Mongolia Extractives Program (EMEP)
Report
The following report for EMEP was funded the Australian Government through the Department of Foreign Affairs and Trade. Its purpose was to provide expert advice ot the Mongolian Government on how to nurture the local mining sector in a way that maximises the value captured by the Government in the longer term.
The report provides an analysis of the current Effective Tax Rate (ETR) for Mongolia and 16 of its peers.
Modeling shows that while Mongolia’s Corporate Tax Rate of 25% is low relative to its peers, the
country’s very high Royalty Rate and its policy of not refunding VAT credits on capital expenditures
results in an ETR (at the Start-of-Exploration Stage) of ~60% for copper projects and ~47% for gold
projects, making it one of the highest amongst its peers.
Detailed modelling was carried out on the economics of the 1148 copper and gold deposits discovered in the World in the last 25 years. The aim was to (firstly) determine how many of these would be built today assuming a given set of tax rules and investment hurdles. Secondly, if developed how much of the economic benefit would be shared between the developer and the Government. And thirdly, determine what is the optimum tax rate that maximises the value captured by the Government.
Conceptually, having a tax rate of 100% will result in no mines being built and no money to the Government. Conversely, setting the tax rate at zero will result in lots of mines being built, but very little revenue to the Government. This study attempts to calculate the optimum tax rate between these two extremes.
Key observations were:
- Using a long-run gold price of US$1500/oz and a copper price of US$3.00, a 30% Corporate Tax Rate a, 59% of the gold discoveries and 39% of the copper discoveries would be developed (based on a hurdle rate of 10% real after-tax). However, this ignores exploration and feasibility study costs. It also ignores the impact of Royalty Rates and country risk – as a result the number of viable projects (and the value captured by the Government) will be much less than this.
- For any given country the Optimum Effective Tax Rate (OETR) depends on:
• Mining Costs; Countries with high costs / poor infrastructure need a lower OETR to offset lower profitability on its projects
• Business Risk: Countries with low-risk can set the OETR at a higher rate
• Mineral Endowment; Countries with low quality deposits need a lower OETR
• Resource Maturity: if the Government’s view is that the potential for new discoveries is exhausted, the Country should focus on maximizing the returns from its existing operations. This means a higher OETR. Conversely, if there are good opportunities to make additional discoveries the Government needs to set the OETR at a low rate so as to encourage additional exploration - The following chart shows that (after adjusting for local Royalty rates and investment rules) most countries operate at or near their optimum tax rate. However the current rate for Mongolia is too high. It also shows that the proposed new Royalty Rules in Chile is likely to have an adverse impact on the mining industry and will reduce the value captured by the Government in the longer term.
FIGURE 1 : Effective Tax Rates of Selected Countries versus NPV to Government for Copper Projects at the Start-of-Exploration
In short, there is no “one-size-fits-all” tax rate for mining industry. Also , the most important policy decision a Government can do to increase the value captured from mining is to find ways to lower the level of perceived business risk – this gives a much bigger pay-off than “tweaking” the tax and investment rules.