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Wednesday, 14 July 2010

The Great Swindle, 3rd Edition

An excellent editorial from the Business Post on Zambia's broken mining policy which continues to see mining companies emerging as a negative contributor to Zambia Revenue Authority through huge tax rebates and their failure to pay existing obligations :


Zambia has over the years been a recipient of substantial foreign investments especially in the mining sector. This has been necessitated by the privatisation of the mines a couple of years ago by Frederick Chiluba’s government. It cannot be denied that since then, mining has been one of the most favoured sectors by the government in Zambia.

Placing the mines in private hands meant that any income to the state will not directly be from sales and profits from the mines, but rather from any taxes that can be levied on the companies – in the form of income tax for employees, VAT paid on services purchased by the mines, border taxes paid on imports and exports, corporate taxes on profits, and mineral royalties on sales of copper – although these are paid just by a few mining companies.

However, as we saw not too long ago, in their Development Agreements, the mining companies managed to negotiate exemptions from paying most of these taxes. Therefore, mining contributions, in general, to total tax revenues are extremely small. This is a source of significant resentment among most well-meaning citizens of this country as the government has been known to be favouring international investors over local business owners.

It is clear that the mining industry only contributes to government revenue through the taxes paid by its employees in form of income tax. However, in their Development Agreements, companies negotiated to pay lower corporate tax rates than apply to other industries. Because they are also able to roll losses from previous years forward and to write off profits that would have been taxable, the mining sector barely contributes at all. We are aware that mining contributes less corporation tax than smaller sectors such as the financial services and telecommunications sector.

The mining sector also claims back from the Zambian government all of the VAT that it pays on goods that it buys locally. Since the company from which these good were initially bought will have paid the VAT aspect of the price charged to the government, and the government then pays that back to the purchaser, VAT contributions show up as a minus figure – a subsidy from government to the mines.

And as Situmbeko Musokotwane, the Minister of Finance and National Planning, has stated in his Letter of Intent to the International Monetary Fund, mining sector contributions to Zambia’s Gross Domestic Product (GDP) over the last decade have not been matched by commensurate contributions to domestic revenues. This is very correct. And it is sad that those charged with the affairs of managing our country’s resources have allowed this to happen for such a long time. Dr Musokotwane himself, as our Minister of Finance, therefore has the duty to ensure that the mines’ contribution to domestic revenue is in line with their GDP contribution. But we wonder if this is an easy task for the current regime owing to their strong opposition to the windfall taxes.

We are aware of the fact that most of these mining companies in Zambia today do not meet most of their tax obligations. Dr Musokotwane says the government has commenced discussions with the mining sector aimed at resolving legacy issues related to the Development Agreements as well as the mines’ adherence to the current tax regime.

But we wonder what the outcome of these discussions will be. We say this because our people have not been part of these agreements that government enters into with the mines although the mining activities take place in communities where people live. In extreme cases, people have been displaced and end up suffering. We have not forgotten that at the time when Development Agreements were still in force, these were highly guarded documents whose contents were considered top secret – only known to the mines themselves and the top government officials.

It is, therefore, sad that the mines continue to contribute minute amounts from their earnings out of our mineral resources despite making enormous profits. This is all as a result of this government’s decision to scrap windfall taxes which would have seen these mines paying reasonable amounts for our mineral resources. But this is what we expect from leaders whose main interest is to satisfy their own needs at the expense of the many suffering citizens of our country who survive on less than a dollar a day.

10 comments:

  1. The net effect of the mines' contribution to ZRA is NOT negative (given some assumptions). let me explain ...

    This is the way I understand how the VAT refund works (maybe I am wrong?):

    A mine purchases a good from a supplier in Zambia. The mine pays the base price plus the VAT component (say X kwacha).

    X kwacha, the VAT part of this trade, is paid by the supplier to ZRA each month.

    At the same time, ZRA pays the mine the X kwacha to the mine in the form of a VAT refund.

    What is the net effect for everyone?

    ZRA - it receives X kwacha from the supplier and refunds the mine X kwacha. Net effect = zero.

    Supplier - received X kwacha from the mine and pays X kwacha to ZRA. Net effect = zero.

    The Mine - pays X kwacha to supplier, receives X kwacha from ZRA. Net effect = zero.


    So despite the mines receiving a large refund, that just happens to be larger than their other tax payments, ZRA does not loose out from this arrangement. Neither does the mine gain any more from this arrangement.

    There is one thing that I have simplified here: it is not necessarily the case that the supplier of the mine will be honest and declare the full amount of VAT to ZRA. In fact I would guess that they do not. So there is some leakkage from this system. But it is not the fault of the mines. It is the responsibility of ZRA to ensure correct tax compliance amongst the suppliers.


    In this I am not saying that there are no problems with the mining regime in Zambia. The mines are paying a positive amount in tax, BUT this amount is far lower than they should be paying, even after taking into account the carry-forward of losses (which is a legitimate tax rule btw). My calculations show that even after the recent increase in tax revenues, tax revenue to sales revenue of the mines is still very low (about 3 - 7 %). Collier in his article (http://www.newstatesman.com/environment/2010/06/natural-assets-rights
    ) says 3% although he is using data from earlier years.

    [There are arguments against these figures but I will not comment on that now]

    The point is that we still need to reform the tax system (principally by closing loopholes like removing the VPT and having ring-fencing) but lets not state things like this VAT case that are not completely correct, even though they make for good headlines.

    ReplyDelete
  2. Richard,

    Two things:

    First, Dr Mpande's assessment is not based on VAT alone it takes on board other exemptions. See the first and second editions, for a fuller picture.

    Secondly, Dr Mpande's assessment focuses on the contribution from the MINING COMPANIES' perspective. Again whether that is the right comparison depends on the counter-factual. The question of whether those transactions would have taken place in the absence of the rebate becomes crucial. He believes they could have and if that was the case then you would to concede that he is correct in his negative assessment since the SELLER's contribution would always be there in the counter-factual.

    ReplyDelete
  3. Chola
    Yes, the assessment is on more than just VAT (I was there for Dr Mpande's speech at the EAZ conference). But one part of his argument is that the VAT refund should count against other tax revenues. He doesn’t add up the revenue foregone from other tax incentives and reduces the tax take by those as well.

    Anyway, lets just look at VAT. You say …

    “The question of whether those transactions would have taken place in the absence of the rebate becomes crucial. He believes they could have and if that was the case then you would to concede that he is correct in his negative assessment since the SELLER's contribution would always be there in the counter-factual”

    Dr Mpande can ‘believe’ what he wants. Yes, if you assume this particular counterfactual then this is the result you will get, but it is not necessarily a realistic assumption….

    We can probably make some good guesses over what would happen if the mines did not have the VAT refund. Given that the VAT rebate is more than all the other tax payments put together it would imply that if the mines did have to pay this, their profits would likely fall quite considerably. I created a simple static model that calculates the effective tax rate for this sort of thing (it’s a one period model, so there is no investment, just operating costs. But it shows results for any range of mineral prices):

    I use an example of a mine with costs per tonne of copper of $3,000. Lets assume that the inputs that at taxed VAT are around 50% of these costs (labour and other inputs don’t have VAT). So by not having a refund, per unit costs effectively rise to $3,240 per tonne. The model shows that profits are reduced by an average of 5% when prices are very high ($6,000 to $9,000), 14% when prices are between $4,000 and $6,000) and by very large amounts as prices fall towards the break even point. In addition the break even point rises from $3,100 to $3,400. By the way, I tested it for other cost levels the results are comparable.
    So the lack of VAT refund dramatically increases the risk for the firm as prices fall. Of course, these calculations were done rather quickly but I am fairly confident they give an indication of the effects of the VAT refund.

    So without the VAT refund, you cant necessarily say that the mining firms would still have decided to invest in Zambia, since their profit profile would have been seriously changed.


    Also, because of the principles behind VAT as a tax on consumption, nearly all mineral countries refund VAT. James Otto says:

    "Because it is a “consumer” tax and export minerals must compete globally, almost all mineral exporting nations have chosen to negate the impact of the tax in one way or another on both export mineral sales and equipment purchases."

    Reference: James Otto (2002), ‘Position of the Peruvian Taxation System as Compared to Mining Taxation Systems in Other Nations’

    (by the way, it is not just mines that get a VAT refund, but all exporters in Zambia)

    This is not to say the VAT refund system is perfect. As I said there is the possibility that the suppliers are not correctly giving ZRA the VAT payments. Furthermore, there is the possibility that the mines are setting up 'fictitious suppliers' and getting refunds off fantasy transactions. ZRA needs to look at this, but it is not an easy task. But then Dr Mpande didn’t mention this aspect of the problem.

    ReplyDelete
  4. Chola
    Yes, the assessment is on more than just VAT. But one part of his argument is that the VAT refund should count against other tax revenues. He doesn’t add up the revenue foregone from other tax incentives and reduces the tax take by those as well.

    Anyway, lets just look at VAT. You say …

    “The question of whether those transactions would have taken place in the absence of the rebate becomes crucial. He believes they could have and if that was the case then you would to concede that he is correct in his negative assessment since the SELLER's contribution would always be there in the counter-factual”

    Dr Mpande can ‘believe’ what he wants. Yes, if you assume this particular counterfactual then this is the result you will get, but it is not necessarily a realistic assumption….

    We can probably make some good guesses over what would happen if the mines did not have the VAT refund. Given that the VAT rebate is more than all the other tax payments put together it would imply that if the mines did have to pay this, their profits would likely fall quite considerably. I created a simple static model that calculates the effective tax rate for this sort of thing (it’s a one period model, so there is no investment, just operating costs. But it shows results for any range of mineral prices):

    ReplyDelete
  5. ...

    I use an example of a mine with costs per tonne of copper of $3,000. Lets assume that the inputs that at taxed VAT are around 50% of these costs (labour and other inputs don’t have VAT). So by not having a refund, per unit costs effectively rise to $3,240 per tonne. The model shows that profits are reduced by an average of 5% when prices are very high ($6,000 to $9,000), 14% when prices are between $4,000 and $6,000) and by very large amounts as prices fall towards the break even point. In addition the break even point rises from $3,100 to $3,400. By the way, I tested it for other cost levels the results are comparable.

    So the lack of VAT refund dramatically increases the risk for the firm as prices fall. Of course, these calculations were done rather quickly but I am fairly confident they give an indication of the effects of the VAT refund.

    So without the VAT refund, you cant necessarily say that the mining firms would still have decided to invest in Zambia, since their profit profile would have been seriously changed.

    ...

    ReplyDelete
  6. ...
    Also, because of the principles behind VAT as a tax on consumption, nearly all mineral countries refund VAT. James Otto says:

    Because it is a “consumer” tax and export minerals must compete globally, almost all mineral exporting nations have chosen to negate the impact of the tax in one way or another on both export mineral sales and equipment purchases.

    Reference: James Otto (2002), ‘Position of the Peruvian Taxation System as Compared to Mining Taxation Systems in Other Nations’

    (by the way, it is not just mines that get a VAT refund, but all exporters in Zambia)

    This is not to say the VAT refund system is perfect. As I said there is the possibility that the suppliers are not correctly given ZRA the VAT payments. Furthermore, there is the possibility that the mines are setting up 'fictitious suppliers' and getting refunds off fantasy transactions. ZRA needs to look at this, but it is not an easy task. But then Dr mpande didn’t mention this aspect of the problem.

    ReplyDelete
  7. If the government won't collect taxes from revenues, and can't track profits, this is what it could do, to collect $1.2 billion a year from the mines.

    Introduce a minimum wage of $15,- per hour in every foreign owned mine, and collect $10,- per hour in PAYE.

    With 58,000 miners, and 2,000 working hours per year, and $10,- per hour, the government would collect $11.6 billion in PAYE per year.

    Problem solved.

    ReplyDelete
  8. I challenge anyone to find where in the Mopani Development Agreement any mention of a limit on the minimum wage.

    And as PAYE is levied by the GRZ on workers, they are not covered by the Development Agreements.

    There is a mention of limiting the withholding tax to 10%. However, the GRZ can even reduce the withholding tax to 0%, and tax workers individually.

    A tax on minimum wage would cover all employees. It would also make it a crime of tax evasion if these companies hide the number of employees, which should be punishable by tax fines and if necessary confiscation of their business.

    The Mopani Development Agreement

    DATED 31 MARCH 2000
    THE GOVERNMENT OF THE REPUBLIC OF ZAMBIA
    and
    MOPANI COPPER MINES PLC

    ReplyDelete
  9. Mr K,

    [I assume you meant $1.16 bn rather than $11.6 bn]

    Thats a nice idea, but I think it would probably have the same effect as removing the VAT refund. With 58,000 workers, working 2,000 hours a year for $15 an hour the total industry wage bill would be $1.74 bn.

    This figure in terms of per tonne of copper produced is $2,576 (if we use Bank of Zambia's production figures for 2009). This is possibly a doubling of costs for the mines, if we think that unit costs must be in the region of $2,000 to $3,000 per tonne. I doubt the mines would agree to that.

    Also, might there a shift to hiring more foreign workers? Presumably the main reason the companies hire local staff is the lower labour costs. If there is a minimum wage, local labour becomes less competitive.

    I dont think we should just accept the refusal of the current government to consider a revenue based tax. Something like the windfall tax (properly implemented, i.e. with deductability) seems to be a viable option. at least until ZRA has the administrative capacity.

    btw, I did not know that the development agreements were actually available on the internet, thanks very much.

    ReplyDelete
  10. Richard,

    [I assume you meant $1.16 bn rather than $11.6 bn]

    You are correct, that was a typo, and you can't edit after you hit send.

    Thats a nice idea, but I think it would probably have the same effect as removing the VAT refund. With 58,000 workers, working 2,000 hours a year for $15 an hour the total industry wage bill would be $1.74 bn.

    Which sounds about right. The entire industry is $5 billion, so spending 34% of that on labour sounds about right to me.

    Remember that this would include all the taxes they would have to pay. So beyond energy and equipment costs, it would all be profits.

    ReplyDelete

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