Breaking the resource curse

December 2008 saw a ‘perfect storm’ hit international metals prices, bringing the five-year international metal price boom to an abrupt end. The combined collapse in demand for metals and sharp drop in the demand of institutional investors for commodity-based assets have slashed copper prices by up to two-thirds, and gold prices by up to a third from their peaks in July 2008.

The metals price bust has dealt a blow to the mining tax reforms undertaken in a few mineral-rich African countries in the past two years. Emboldened by the metals price boom, governments in Zambia, Tanzania, South Africa and the Democratic Republic of Congo have amended their mining tax legislation or contracts with mining companies to increase the revenue they collect from mining rents. They did so partly under public pressure – African citizens have been all too aware that while the ‘good times were rolling’ for the global mining industry, they saw no increase in mining tax revenue to governments or spending on their basic development needs.

The poor balance sheet of mining tax revenue in times of record high metal and mineral prices has motivated African and international non-governmental organisations to collaborate in commissioning a study on mining taxation and transparency in seven African countries. The countries are Ghana, Tanzania, Sierra Leone, Zambia, Malawi, South Africa and the Democratic Republic of Congo (DRC). Each country study examined past and present mining tax laws, tax rates and the forces driving tax changes, and compared the tax terms of mining contracts with national tax laws.

The central argument made by the report is that African governments have not been able to optimise the mining tax revenue due to them before the 2003 to 2008 price boom; neither have they been able to capture the anticipated windfalls during the price boom. This argument is grounded on two main reasons: i) Mining companies operating in Africa are granted too many tax subsidies and concessions; and ii) There is high incidence of tax avoidance by mining companies conditioned by such measures as secret mining contracts, corporate mergers and acquisitions, and various ‘creative’ accounting mechanisms. These two factors, coupled with inadequate institutional capacity to ensure tax compliance, contribute in large measure to diminishing the tax revenue due to African governments. In turn, they diminish the contribution of mineral resource rents to national development. This explains the high preponderance of income poverty indicators in mineral endowed African countries and communities in mining areas. To reverse this trend and ensure the maximisation of mining tax revenue for national development, the report recommends reforms of policies, laws and institutions that govern the financial payments made by mining corporations to national governments.

Mining companies claim that they need to be compensated for the unique risks they face, such as price booms and busts, through special tax exemptions and concessions. But these tax subsidies, together with tax avoidance and alleged tax evasion practices by mining companies, have robbed African treasuries of millions of dollars of foregone tax revenue from the mining industry. Fuelling these losses has been a lack of transparency and oversight of the financial remittances from mining companies to government institutions, coupled with the inability of government institutions to audit the complicated accounts of multinational mining companies.

HOW TAX SUBSIDIES AND TAX AVOIDANCE ARE DRIVING DOWN REVENUES FROM MINING

This report argues that African governments have failed to collect the additional rents generated by mining companies before and during the price boom because i) they have given tax subsidies to the industry and ii) mining companies have been pushing for tax breaks in secret mining contracts, amounting to an aggressive tax avoidance strategy. As a result, the citizens of mineral-rich countries continue to live in poverty, and are in some cases subject to violent conflict fuelled by the wealth generated from mineral resources, as is the case today in the eastern DRC. To break this ‘resource curse’ and turn mineral wealth into revenue for development, the laws, policies and institutions that govern the financial payments made by mining corporations to national governments need to be reformed.

In the report, estimates are given of the revenue foregone by the governments of Malawi, South Africa, the DRC, Tanzania, Sierra Leone, Ghana and Zambia as a result of the special tax breaks given to companies in secret contracts or in the mining tax laws promulgated in these countries since the 1990s. In Ghana, South Africa and Tanzania, the report estimates that lower royalty rates have cost or will cost treasuries up to US$68 million, US$359 million and US$30 million a year respectively. In Malawi and Sierra Leone, tax breaks granted in mining contracts have cost or will cost treasuries up to US$16.8 million and US$8 million a year respectively. In the DRC, the tax exemptions in a single mining contract have cost the treasury $360,000 a year.

African mining tax regimes are a mix of secret and discretionary tax deals, as well as tax laws enacted through parliament. Most mining tax laws dating from the 1990s have lowered taxes considerably to attract new foreign direct investment into the sector. This shift to lower taxes has been promoted by the World Bank in all its client countries in Africa as a means to revitalise the mining sector. Many of these laws allow ministers to negotiate tax deals with individual mining companies at their discretion, often leading to lower royalties, corporate taxes, fuel levies, windfall or other taxes than those stipulated in the law. At their worst, contracts may completely exempt companies from any taxes or royalties, as was the case in a number of the mining contracts signed between private companies and state-owned enterprises in the DRC between 1997 and 2003.

TRACING THE LEGACY OF WORLD BANK-DRIVEN MINING TAX REGIMES

This report traces the history of mining tax regimes in Africa since independence, throughout the booms and busts in international metal prices. It pays particular attention to the drive of the World Bank to open up Africa’s mining sector to foreign private investors since the 1990s, which has shaped subsequent mining tax regimes in all its client countries. Next, the report argues that revenue is the key development benefit from mining, which explains why an equitable and transparent mining tax regime is of paramount importance if mining wealth is to translate into future development.

The core of the report investigates the tax subsidies given to mining companies in mining tax laws and contracts, and gives estimates of some of the costs of these exemptions. These subsidies take the form of lower tax rates and higher and faster tax deductible capital allowances. It then investigates the tax avoidance strategies used by mining companies, focusing primarily on the negotiation of tax breaks in secret mining contracts. This tax avoidance strategy is in contravention of the Organisation for Economic Co-operation and Development (OECD) Guidelines on Multinational Enterprises, to which many of these companies claim to ascribe. Some mining companies have also been accused of illegally evading taxes – in Tanzania a government-commissioned auditor has alleged that the country’s four main gold mining companies have over declared their losses by millions of dollars.

HOW TO INCREASE THE REVENUE COLLECTED FROM MINING ACTIVITY

To reverse the ‘paradox of plenty’ characteristic of many mineral-rich societies in Africa, whereby countries with the most natural resources are often the poorest and worst governed, two major changes are needed. First, the process of creating tax regimes and mechanisms of tax payment need to become transparent. This transparency requires equal opportunities for citizens to monitor payments, receipts and the utilisation of mineral tax revenues. To contribute to such transparency, a new international accounting standard, requiring all multinational companies to report on their remittances to governments and their profits and expenditures in each of the countries where they operate, needs to be established. The International Accounting Standards Board is presently discussing whether or not to introduce such a standard for the extractive sector. This would be an important systemic reform which would enable governments and citizens to track where companies pay tax, and how much. This would make it more difficult to shift profits between subsidiaries of different companies. Second, African mining tax regimes need to be reformed to ensure that African governments are able to collect a fair share of mining rents to fund their national development plans. In some countries, this would require an increase in the rates of royalties and other taxes; in others this would require prohibiting the practice of negotiating tax breaks for individual companies in secret contracts.

There is a real danger that the crash in international mineral commodity prices coupled with the reduction in international finance available for new mining investment could set back the mining tax reforms underway or recently enacted in countries like Tanzania and Zambia. In Zambia, the minister of finance announced in his budget speech at the end of January 2009 that he will reverse a tax amendment passed in parliament less than a year ago, introducing a new windfall tax. In Tanzania, the minister of finance has failed to implement any of the tax increases recommended by a presidential commission tasked to review the country’s mining tax regime in his June 2008 budget speech. However, he did introduce a turnover tax on companies declaring losses three or more years in a row, directly aimed at mining companies.

Too many African governments are still unwilling to open up their tax deals and tax receipts from mining companies to public and parliamentary scrutiny. Transnational mining companies have also been pushing for tax exemptions, and fail to report what they earn and what they remit to government in each jurisdiction where they operate. The credit crunch and its impact of a reduction in finance available for mining investment are set to motivate governments to continue such secret deals. The crunch will also give mining companies the moral instrument to demand more exemptions. These are systemic and political complications that threaten the reform agenda.

The report argues however, that both systemic and political solutions are needed to increase mining revenue and transparency. At the systemic level, a new international financial reporting standard is needed, which all companies registered on stock exchanges will need to implement. It should require them to report on their financial operations and remittances to government and other structures on a country-by-country basis. This will allow citizens and parliaments to monitor the financial flows between parent companies and subsidiaries, and detect tax avoidance practices.

African governments also need to revise their company acts to require the subsidiaries of multinational mining companies incorporated in their jurisdictions to publish the financial information required by the Extractive Industry Transparency Initiative (EITI). This will ensure that privately or state-owned mining companies, such as the growing number of Chinese state-owned or financed mining companies, are required by national law to publish their profits and losses and remittances to government and other structures.

RECOMMENDATIONS

To African governments:

- Collaborate with the United Nations Economic Commission for Africa (UNECA) to develop and publish an easy-to-use guide on mining taxation. The guide should cite best practice and detail the purpose, costs in foregone revenue and benefit of each type of tax instrument and tax concession.
- Review their company and financial laws to require all extractive industry companies to use the EITI template in their annual financial reports by law.
- Stop the practice of granting tax exemptions to mining companies in mining contracts. All mining tax rates and terms should be legislated in the substantive law and merely confirmed in mining development agreements.

To African parliaments:

- Pass laws that require mining development agreements to be ratified by parliaments, as is the case in Ghana and Sierra Leone, and be made public.
- Push for a new international accounting standard that would force companies to report on their profits and expenditures, with taxes, fees and community grants paid in each financial year on a country-by-country basis.

To the International Accounting Standards Board:

- Adopt a new international accounting standard for extractive industries, which requires them to report on their profits, expenditures, taxes, fees and community grants paid in each financial year on a country-by-country basis.

To bilateral and multilateral donors:

- Scale up their financial assistance to African governments to improve their capacity to monitor and audit the accounts of mining companies, and to review their mining tax regimes. African governments should be free to use this finance to purchase legal and other technical assistance from any service provider of their choice.

* This article is an executive summary of a recently published report. The full report is available at http://www actionaid.org/docs/breaking the curse full report...pdf.
* This report was edited by Kato Lambrechts, with contributions from Abdulai Darimani, Claude Kabemba and Wole Olaleye. The core findings of the report are based on research conducted by Mark Curtis, Tundu Lissu, Thomas Akabzaa, John Lungu, Alastair Fraser, Laurent Okitonemba, Dona Kampata, and Patrick Kamweba. Alex Cobham, Rachel Moussie, Paul Valentin, and Richard Murphy have provided comments. The report was published by Southern Africa Resource Watch, TWN-Africa, Tax Justice Network for Africa, ActionAid and Christian Aid.
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