Mineral Taxation System

MINERAL TAXATION SYSTEM

OUTLINE

Introduction Legal framework : mining taxation Types of Taxes Tax sharing between Centre and State Prospecting fees, Royalty , Dead Rent, surface rent Current royalty regime in India Current reforms Conclusion

INTRODUCTION

Mineral tax systems vary widely in the world. In each country, there exists a gamut of levies, each with a plethora of components impinging on the mineral sector at various stages of prospecting, exploration, trade and final consumption.

The high risk, high capital-intensity characteristics of the mining activity coupled with long gestation lags involved in prospecting and extraction call for special tax treatment of the sector

CURRENT ISSUE: STATES FEEL THAT THEY ARE NOT BEING ADEQUATELY COMPENSATED

Rising mineral prices do not get reflected in their receipts

States not in a position to remedy the situation Most mineral rich states are among the poorest

EMERGING ISSUE I

Shortfall in mining investment is hurting infrastructure; Greater private investment required

Geology and tax regime are important factors in investment decisions.

High tax burdens will make mineral products globally uncompetitive

EMERGING ISSUE II:

Growing public concern with environmental degradation due to mineral extraction.

Use of environmental resources can be with or without spillover effects.

Mineral taxation impacts rates of extraction and depletion dates

PRINCIPAL ISSUES AFFECTING TAXATION SYSTEMS

CHARACTERISTICS OF A GOOD MINERAL TAX SYSTEM: INVESTOR’S VIEW

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Tax system should:

• maximize the net present value of the company’s revenue

• be based on realized profitability

• permit early pay-back of capital

• be stable and predictable

• transparent

• avoid tax types that do not reward increased efficiency

• encourage investment in exploration

• encourage investment in marginal mines

• maximize the net present value of tax revenue

• capture more revenues during periods of high profits

• be effective with low-cost administration


- PRIMARY GOAL OF MINING TAXATION POLICY -

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• society’s objectives: achieve development and obtain income at an acceptable social cost

• company’s objective: achieve adequate return on investment

It is in the interest of both parties to obtain successful projects


THE GOVERNMENT’S TAXATION DILEMMA: FISCAL DIVERSITY OR UNIFORMITY?

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• same tax treatment for all sectors? (fishing, light industry, mining)

• each sector can claim some uniqueness • special treatment can cause distortions between sectors

Government dilemma: Uniform tax system applicable to all sectors

or system that accounts for uniqueness in each

sector


SHOULD THE TAX SYSTEM ADJUST FOR PRICE CYCLES?

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When prices are high:

Surpluses are available to be taxedSpecial taxes: additional profit tax, graduated royalty

When prices are low:

Without relief from non-profit based taxes, mines may close

Most mineral fiscal system today partially self-adjust because they are based mainly on profitability

(income tax, withholding tax on remittances)

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- UNIQUE NATURE OF MINING: TAX POLICY RESPONSE -

Trend is to harmonize fiscal systems across

economic sectors, but most nations still provide

some special treatment to the mining sector

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- UNIQUE NATURE OF MINING: TAX POLICY RESPONSE -

Mine will initially import equipment from specialized suppliers.

Response: low or no import duty and VAT relief

Mineral product must compete for share of global market.

Response: relief from VAT and export duties

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Community related costs – deductible/credits?

clinic / school / water supply / housing / nutrition

TYPES OF TAXESEXCISE TAX

Excise tax or Cenvat is based on the manufacture of goods within India and is governed by Central Excise Tax Act 1994. The rate of excise duty are as determined under the Central Excise Tariff Act 1985(CETA)

Minerals are classified under chapter 26 of CETA. Minerals are generally exempted from excise duty vide specific notification. However Cess is levied on mineral Ore under various legislations.

Currently there is an exemption from cess on production of iron ore and manganese ore but production of crome ore still attracts cess of Rs6/- per metric tonne.

CUSTOM DUTY

Custom duty is levied on the import of goods in India. At present the effective custom duty rate is 24.2%.

Minerals import generally attract lower duties on 2 counts First, minerals are not subject to excise duty when produced locally, as a result the additional custom duty in lieu of excise duty is zero

Secondly the basic custom duty on minerals such Iron Ore , manganese and bauxite is lower than the general rate.

Overall the effective custom duty rate on iron ore is 6.14% whereas it is 14.17% for limestone and dolomite

VAT

VALUE ADDED TAX: Presently in most states minerals are liable to VAT at rate of 4% however precious metals like gold and silver are taxed at reduced rate of 1%

Mining like any other sector attracts corporate taxes under the Income Tax Act 1961.

For example: Corporate Income Tax- any company corporated in India or having its management and control in India is liable to pay taxes. The effective corporate tax rate is 33.99% of domestic companies and 42.23% of foreign companies.

TAX-SHARING BETWEEN CENTRE AND STATE

10th Finance Commissions - June 1992

Completion - 19 year of Tax-Revenue sharing between Centre and the State in India

Case study in Fiscal federation but leads to certain reflection in this area of tax dissolution from the Centre to the State

Earlier, the central income tax and the central excise duty were shared by the Centre and the states.

FORMULA ON CENTRE AND STATE TAX SHARING

Finance commission suggests the formula for sharing of taxes between the Centre and states

The report of the commission is significant as it comes just before the government is considering major direct and indirect tax reform

commission will have to take into consideration the impact of these changes while deciding the devolution to the states from the taxes collected by the centre. These include income tax and various indirect taxes such as excise, customs and service tax.

The commission’s suggestions, which will cover a five-year period starting from April 1 2010, are not binding, but they are generally implemented by the government. The Commission was asked to submit its report by October 31 2009.

Three months extension. In a representation to the commission, state governments had asked for an increase in their share in the divisible pool of the central taxes to 50% from the current 30.5%.

They had also demanded that all central surcharges and cess should be included in the divisible pool.

At present, money collected through cess that are imposed for specific purpose and are not shared with the states.

PROSPECTING FEES AND ROYALTY

Under the MMRD Act, Prospecting Fee The holder of a Prospecting License is required

to pay annually, in advance, a prospecting fee in respect of the ensuring year or part of the year at such rates and time as may be fixed by the State Government, being not less than 50 paise and not more than 5 rupees per hectare of land.He or she is also liable to pay royalties at the rates specified in Schedule II to the MMRD Act, in the case of minerals to be removed for commercial purposes and on quantities removed in excess of those specified in Schedule III of the Mineral Concession Rules of 1960.

ROYALTY

The holder of a Mining Lease is liable to pay royalties in respect of any mineral removed or consumed by him or her from the leased areas at the rate specified in the MMRD Act.

The Central Government is empowered to increase or reduce the rate of royalty, but it cannot increase the rate in respect of any minerals more than once during any three-year period. The royalty is to be paid at such a time and in such a manner as the State Government may prescribe.

ADVANTAGE OF ROYALTY

Royalties have the advantage over other tax instruments in yielding an early minimum and relatively assured flow of revenue to governments and it is more straight forward and simpler than tax administration.

Sometimes, royalties are major or the other source of revenue to government from a producing mine, particularly, during the early years of its productive life, and when the company has accumulated high capacity allowances for income tax purposes, or during times when mineral production is comparatively low.

DISADVANTAGE OF ROYALTY

The drawback of imposing royalties is that they are generally insensitive to mine profitability and are regressive in nature in the sense that marginally economic projects may be affected by them more heavily, than more profitable mines.

This regressive feature of royalties arose from the fact that royalty may tend to form a high proportion of net cash flow for a marginally economic mine than a more profitable one.

DEAD RENT

The holder of a Mining Lease must pay to the State Government annual dead rent at such a rate as may be specified in the MMRD Act, for all areas included in the Mining Lease.

Dead rent is the rent fixed for mines without considering the fact whether the mine is profitable or not. It is mostly fixed in a mineral lease. This rent must be paid whether or not minerals are being extracted from the mines. Even though mining comes under the category of one of the most hazardous occupation and expectation of profit is limited, mining leases fix dead rents on mining sites.

Dead rent is a deterrent against the tendency of leaseholders in cornering the mining lease and keeping the mineral resources idle.

Ideally, the ‘dead rent’ should have some relationship with economic values of mineral resources which are kept idle by the lessees and not merely with surface area of the idle leases.

generally, one year is required for mine development, and the same may be exempted from levy of dead rent.

SURFACE RENT

The lessee is required to pay for the surface area used for mining operations, at a rate not exceeding the land revenue, as may be specified by the State Government in the Mining Lease

CURRENT ROYALTY REGIME IN INDIA

Major minerals: GoI fixes, but are collected and retained by states

Tax system is uniform across states Changes in rates allowed once in 3 years

(stability) Regime moving progressively towards ad

valorem

CONTD..

Still, 22 out of 51 attract specific rates, incl important ones like coal; grade-wise rates for 6 (removes distortion)

Ad valorem incidence of specific rates vary from 1-2 % for iron ore to 25-35 % in case of limestone

Balance 39 items, rates vary from 1 % (mg concentrate to 20 % (gypsum)

Base & precious metals: fixed % of metal content value based on LME price

Minor minerals: States have powers to fix and collect

Royalty Systems

Quantity-based(rate

per ton)

Value-based (%

of revenue)

Profit-based (%

of net profit)

ADVANTAGES OF QUANTITY - BASED

•Easy to administer

Problem•Is not price neutral•Tilts time path•Raises cut-off grade

ADVANTAGES OF VALUE- BASED

•Revenue buoyancy•Price neutrality

Problem•No benchmark in case of some•Encourages under-reporting•Transfer pricing (captive)

ADVANTAGES OF PROFIT BASED

Less distortionary•More equitable

Problem•Uncertainty in yield•Problems in administration

RECOMMENDATIONS OF HODA COMMITTEE

Mode: Move decisively to ad valorem rates Base: Transaction value; should include profit

element over unit cost of production Sale price rather than pit mouth value Sale price to be adjusted for transaction

costs etc Beware of transfer pricing by captive mines Illegal mining: Non-bailable, cognizable

criminal offence; special courts

PROBLEMS WITH PROPOSED SYSTEM

Overestimates economic rent - Ignores capital costs in resource

exploitation - Desirable investment may be discouraged,

especially at high tax rates Double taxation of capital income when royalty

coexists with corp. tax - Corp taxes are levies on capital income - Non-deductibility of capital costs means

royalty is based on (economic rents plus capital income)

Government has no clue on how much it can tax without dissuading investment

WAY FORWARD: PRODUCTION SHARING CONTRACT (AS IN PETROLEUM)--EFFICIENCY THROUGH COMPETITIVE BIDDING

Prior to 1999 Majority of block allocation on nomination basis to

ONGC and OIL. No competition, no incentive => Sluggish

investment; poor exploration Post 1999 Allocation on competitive bidding basis with

transparent bid evaluation criterion Private participation allowed; 100 percent FDI Govt gives license without making any financial

commitment for itself

Basis for bid evaluation: (I) financial standing and technical capability, (II) work commitment and (III) fiscal package meaning what % of profit petroleum to be shared with Govt.

Model production sharing contract provides fiscal stability to the investors

Quality of exploration has improved 162 blocks allocated; already invested $ 3

billion; commitment: $ 8 billion

CONCLUSION Mineral sector activities attract several taxes

in highly diversified forms.

The conclusion is that if a government were to tax away the full pure rent, this would undermine the long-term viability of a country’s mineral sector.

The policy conclusion of the theoretical literature on minerals taxation is that ‘ fair sharing’ of revenue between government and companies ought to focus on sharing the pure rent ‘

If a country is interested in the long term viability of its mineral sector, it should leave a sufficient share of the pure rent to companies in order to retain their interest in the continued development of the country’s mineral sector.

Fiscal costs of projects to be developed in India as well as in selected foreign countries to help in the assessment of the economic viability of investments for exploration, mining and design for taxation cum policy packages in India.

The Government should therefore boost taxation while also lifting price controls and liberalizing the capital market.

State ownership of natural resources such as minerals create unique challenges in maintaining fiscal responsibility.

Well-designed institutions may present part of the solution, but multiple examples illustrate that without political will to maintain and enforce them, even the best institutions cannot prevent interference.

Thank You…

Mineral Taxation System

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