Mineral and Petroleum Resources Royalties Bill

September 2008

2

Contents

1 Background, MPRDA, Royalty Bill consultation process2 Why mineral royalties – economic rationale3 Refined and Unrefined minerals4 Tax base: Gross Sales5 Mineral royalty rates: Formulae6 EBIT, with 100% capital expensing7 Estimated mineral royalty rates8 Rollover relief & Unincorporated bodies9 Small business relief10 Fiscal stability11 Transitional measures12 Administration13 International examples14 Mining Value Chain: Exploration, Mining, Mineral Processing,

Refining: First saleable point

3

Mineral and Petroleum Resources Royalty Bill (B 59 – 2008)

1. Definitions2. Imposition of royalty3. Determination of royalty4. Royalty formulae5. Earnings before interest and taxes (EBIT)6. Gross sales7. Small business exemption8. Exemption for sampling9. Rollover relief for disposal involving going concerns10. Transfer involving body of unincorporated persons11. Arm’s length transactions12. General anti-avoidance rule13. Conclusion of fiscal stability agreements14. Terms and conditions of fiscal stability agreements15. Foreign currency16. Transitional rules17. Act binding on State and application of other laws18. Short title and commencement

4

Ownership of Land and Minerals

• Surface rights

• Mineral rights

• Land restitution and land reform

• Indigenous communities

• State

5

Background

• Mineral and Petroleum Resources Royalty Bill (MPRRB) follows on the Mineral and Petroleum Resources Development Act (MPRDA), (Act 28 of 2002)

• 1st draft Mineral and Petroleum Royalty Bill released for public comment on 20 March 2003

• 2nd draft of Royalty and Petroleum Resources Royalty Bill released for public comment on 11 October 2006

• May / June 2007 - Consultation, workshops• 3rd draft of Royalty and Petroleum Resources Royalty Bill released for public

comment on 6 December 2007• 4 March 2008 - Briefing by National Treasury to PCOF, 3rd draft• 11 & 19 March 2008 - PCOF public hearings,• 23 April 2008 – Consultation, workshop, preparation for 4th draft• 13 May 2008 - PCOF briefing policy changes, basis for 4th draft• 03 June 2008 - 4th draft published for technical comments only• 17 June 2008 - PCOF briefing, 4th draft• 24 June 2008 – Parliament, Minister of Finance - Introduction of Bill

6

Mineral and Petroleum Resources Development Act (Act No. 28 of 2002)

(MPRDA)

The “MPRDA” provides for:– All mineral rights to vest with the State– Conversion of “old order” mineral rights into “new

order” rights by 1 May 2009– Imposition of mineral royalties by the State:

Section 3 (2): As the custodian of the nation’s mineral and petroleum resources, the State, acting through the Minister may: (b) in consultation with the Minister of Finance, determine and levy, any fee or consideration payable in terms of any relevant Act of Parliament.

7

Mineral and Petroleum Resources Development Act (Act No. 28 of 2002):

Community royalties • The MPRDA Act reserves the right of communities to

receive a consideration or royalty. • Item 11 of Schedule II of the Act states:(1) Notwithstanding the provisions of item 7(7) and 7(8), any

existing consideration, contractual royalty, or future consideration, including any compensation contemplated in section 46(3) of the Minerals Act, which accrued to any community immediately before this Act took effect, continues to accrue to such community.”

(2) The community contemplated in (1) must annually, and at such other time as required to do so by the Minister, furnish the Minister with such particulars regarding the usage and disbursement of the consideration or royalty as the Minister may require.

8

Why mineral royalties (1)

“Although the structure and rates of mineral royalties vary internationally, most are collected for the same reason, that is payment to the owner of the mineral resource in return for the removal of the mineral from the land. The royalty, as the instrument for compensation, is payment in return for the permission that, first, gives the mining company access to the minerals and second, gives the company the right to develop the resource for its own benefit”. (James Otto, et al – The World Bank, page 42)

9

Why mineral royalties (2)

“Another way in which a mine differs from other businesses is that it exploits a non-renewable resource that, in most cases, the taxpayer does not own. In the majority of nations, minerals are owned by the state, by the people generally, or by the crown or ruler”. (James Otto, et al – The World Bank, page 16)

10

Tax base - mineral royalties

“Across the globe, no type of tax on mining causes as much controversy as a royalty tax. It is a tax that is unique to the natural resources sector and on that has manifested itself in a wide variety of forms, sometimes based on measures of profitability but commonly based on the quantity of material produced or its value”. (James Otto, et al – The World Bank, page 1)

11

Tax base = Gross Sales less transport costs (clause 6)

• Gross Sales =

– Proceeds of a transferred mineral resource at its readily saleable condition (i.e., refined or unrefined (“concentrate”) state of mineral as specified)

– Disregard transportation costs of “final product” (including insurance and handling charges)

12

Refined and Unrefined minerals (clause 1, and Schedules 1 and 2)

1. Refined (Schedule 1):• Gold; 99.5%• PGM – refined; 99.9%• Copper; 99.0%• Zinc; 98.5%, • Etc; &• Oil & Gas

2. Unrefined (Schedule 2): • Diamonds• PGM – concentrate• Iron ore; (between 61% to 64% Fe)• Coal – various grades• Manganese (between Mn37% to Mn48%)• Chrome (between 37% to 46% Cr2O3)• Mineral Sands• Zinc concentrate; 27% Zn• Uranium (80% concentrate)• Aggregates; Bulk• Etc.• Other; Concentrate or Bulk

13

Gross Sales - Refined: Schedule 1 (clause 6)

• General Rule:– Gross sales of refined minerals equal amounts received or accrued

(use spot rate if foreign currency is involved)– However, an override exists to ensure that all transactions occur at

arm’s length• Different Condition:

– If a refined mineral is sold above the refined Schedule 1 condition, (unlikely event) the gross sales price is reduced to a hypothetical refined condition price

– If a refined mineral is sold below the refined Schedule 1 condition, the gross sales price is increased to a hypothetical refined condition price (or schedule 2 – unrefined formula)

• Stolen, Destroyed or Lost:– A deemed sales price applies at the proper condition so a royalty is

always charged even if no proceeds are obtained– Rationale: Prevents evasion plus Government should not incur the

risk of a permanent loss (e.g. stolen) of a non-renewable resource

14

Gross Sales – Unrefined: Schedule 2 (clause 6)

• General Rule:– Gross sales of unrefined minerals equal amounts received or

accrued (use spot rate if foreign currency is involved)– However, an override exists to ensure that all transactions occur at

arm’s length• Different Condition:

– If an unrefined mineral is sold above the unrefined Schedule 2 condition, the gross sales price is reduced to a hypothetical refined condition price

– If an unrefined mineral is sold below the unrefined Schedule 2 condition, the gross sales price is increased to a hypothetical refined condition price

• Stolen, Destroyed or Lost:– A deemed sales price applies at the proper condition so a royalty is

always charged even if no proceeds are obtained– Rationale: Prevents evasion plus Government should not incur the

risk of a permanent loss of a non-renewable resource

15

Dual Schedule Minerals

• Some minerals fall under both schedules (e.g. platinum)

• In these circumstances, the mineral will be viewed as refined if developed to or above the refined condition; otherwise, view as unrefined

• Example:– Platinum 99,9% or above view as refined– All other conditions view as unrefined

16

Tax rates – formula (clause 4)

(X = EBIT/Gross Sales *100)

1. Y (r) = 0.5 + X/12.5 (Max = 5.0) Refined metal (e.g. refined Gold,

refined PGM, etc.), and Oil and Gas

2. Y (c) = 0.5 + X/9.0 (Max = 7.0) Unrefined; Concentrate Coal, Rough Diamonds, Iron Ore, etc.

17

EBIT: Basic Calculation (clause 5)

• EBIT = “taxable income” before interest and taxes

• EBIT: Additions – Gross sales (slides 13 and 14)– Recoupment / recapture of depreciable mining

equipment• EBIT: Subtractions

– All operating expenses– All depreciation/CAPEX for machinery employed

to extract/upgrade/refine the mineral • If EBIT < zero, assumed to be zero.

18

EBIT: Adjustments (clause 5)

• No deductions for financial instruments (other than hedges against mineral sales)

• No deduction for the royalty itself (to avoid circularity)• Transport between buyer/seller (and beyond the

refined/unrefined condition)• No carryover of excess operating expenses (but

unredeemed mineral CAPEX can be carried over)• Oil and gas also 100% write-off: deny additional

allowances in terms of the Tenth Schedule

19

Composite Minerals (clause 5)

• When an ore body contains a combination of minerals

• General Rule: Allocate EBIT deductions (refined versus unrefined) according to a reasonable method consistently applied

• De minimis: Less than 10% portions can be viewed as the dominant portion if desired (and if consistently applied)

20

Estimated Mineral Royalty RatesY = 0.5 + X/12.5 (Refined)Y = 0.5 + X=/9 (Unrefined)

 Profitability RefinedUnrefined / Concentrate

EBIT/ Gross Sales (%) Min = 0.5 Min = 0.5

  B = 12.5 B = 9.0

0 0.5 0.5

10 1.3 1.6

15 1.7 2.2

20 2.1 2.7

25 2.5 3.3

30 2.9 3.8

40 3.7 4.9

50 4.5 6.1

56 5.0 6.7

58.5 5.2 7.0

70 6.1 8.3

21

 Mining: R million: StatsSA, P0044: 28 March 2008 2006 2007

1 Turnover received 203,467 291,737

2 Interest paid 5,398 6,794

3 Depreciation 15,358 19,667

4 Net profit before taxation 42,271   82,161

5 Total capital expenditure 36,090 33,777

6 Book value of assets 192,607 216,116

  % Gross revenue:      

7 Net profit before taxation 20.8% 28.2%

8 EBIT ( Depreciation ) 23.4% 30.5%

9 EBIT ( Capital expensing ) 13.2% 25.7%

10 EBITDA 31.0%   37.2%

22

 Financial ratios

Est. Royalty Rates 

 Financial ratios

Est. Royalty Rates 

 Mining: R million: StatsSA, P0044 2006 2006 2007 2007

  Estimated Royalty Rates   Rate   Rate

  Refined: Y = 0.5 +X/12.5      

11 EBIT ( Depreciation ) 23.43 2.37 30.5 2.94

12 EBIT ( Capital expensing ) 13.24 1.56 25.7 2.55

  Unrefined: Y = 0.5 = X/9.0        

13 EBIT ( Depreciation ) 23.43 3.10 30.5 3.9

14 EBIT ( Capital expensing ) 13.24 1.97 25.7 3.4

23

Rollover relief and Unincorporated Bodies (clauses 9 &10)

• Rollover Relief:– If minerals are sold pursuant to the sale of a going concern

(e.g. the whole mining business or a severable part), rollover relief applies

– If rollover relief applies, the transfer is ignored and the transferee assumes the royalty liability upon subsequent sale

• Unincorporated Bodies (e.g. Partnerships):– An election can be made to tax the body (and not the

members on their proportionate share)– The body is effectively viewed as a separate “extractor” with

the members being jointly and severally liable

24

Miscellaneous (clauses 7,8,12,13, &14)

• Small Business Relief:– Relief applies if the royalty otherwise imposed does not

exceed R100 000 (and if gross sales do not exceed R10.0 million)

– Rules against dividing-up big companies into small businesses

• Sampling Relief:– Exemption for sampling/testing (linked to section 20 of the

MPRDA)– Up to R100 000 of gross sales

• General Anti-Avoidance Rule:– Standard for most tax acts

• Fiscal Stability:– Fixed parameters of formulae guaranteed

25

Transitional Rules (clause 16)

• Effective Date:– Transfers occurring on or after 1 May 2009– Applies even if parties only lodge for conversion as of 1 May 2009

(i.e. the royalty cannot be delayed further)• Transitional Credits:

– Previous consideration paid to the State for old order rights (State Lease Payments) to be offset (i.e. a credit) against the royalty

– Might be of importance in the case of minerals won/recovered before 1 May 2009 (and State lease paid) and transferred afterwards

– Also important for parties that only have lodgings but not yet converted on 1 May 2008 (and hence both State Lease Payments and new Royalties are due)

– No credit for certain profit sharing arrangements (i.e. Diamonds) and considerations to communities

26

Mineral and Petroleum Resources Royalty (Administration) Bill

(B 60 – 2008)1. Definitions2. Registration3. Cancellation of registration4. Election for unincorporated body of persons5. Payments in respect of estimated royalty6. Submission of return and final payment7. Form, manner and place determined by Commissioner8. Maintenance of records9. Notice of assessment10. Reduced assessments11. Withdrawal notice of assessment12. Time limit for notice of assessment13. Refunds14. Penalty for underestimation of royalty payable15. Adjustment if estimated royalty16. Interest17. Administration of Act18. Applicability of Income tax Act19. Reporting20. Regulations21. Short title and commencement

27

Administration (Administration Bill, clauses 1 to 20)

• SARS the collecting agent• Two 6-monthly estimated payments• Final payment (6 months after the close of

the financial year)• A potential 10% penalty exists if both

estimates fall short by 20% of the final amount

• Treasury has the power to request individual taxpayer information

Thank you

Mining and Mineral processing

30

THE FOUR STAGE BENEFICIATION PROCESS (Chamber of Mines)

Stage Mineral beneficiation process category

Process flow-chart Labour intensity

Capital intensity

1

2

3

4

The action of mining andproducing an ore or

concentrate (primaryproduct)

The action of converting aconcentrate into a bulktonnage intermediate

product (such as a metalor alloy)

The action of converting theintermediate goods into a

refined product suitable forpurchase by both small &

sophisticated industries (semis)

The action ofmanufacturing a final

product for sale

Run-of-mineores

Washed &sized

concentrates

Mattes/slags/bulk

chemicals

Ferro alloys /pure metals

Steel/ alloysWorked

shapes &forms

Workedshapes &

forms

Workedshapes &

forms

High High

Low High

Low High

Medium tohigh

Medium tohigh

IndustryCluster

Mining

Mining

Refining /Manufacturing

Manufacturing

Mining

Manu-facturing

31

Mineral Beneficiation Value Chain (Mintek / DME)

Capital requirements & Services• Exploration

– Geophysics– Drilling– Survey

• Mining– Drilling– Cutting– Hauling

• Mineral processing– Crushing– Hdyro-met. Plant– Material handling– Furnaces

• Refining– Smelter– Furnaces– Electro-winning

cells, Casters• Value addition

– Rolling & moulding– Machining– Assembling

• Exploration– GIS– Analytical – Data processing

• Mining– Mine planning – Consumables – Sub-contracting

• Mineral processing– Comminution – Grinding, media – Chem / reagents

• Refining– Reductants – Chemicals – Assaving

• Value addition– Design – Marketing – Distribution

32

Estimated royalty rates – Refined / Metal

EBIT (“accounting” depreciation)

/Gross revenue = X

Y = 0.5 + X/12.5 (Max = 5.0) 2002 2003 2004 2005 2006 Average

PGM - metal (refined) 3.4 2.2 2.1 2.2 3.6 2.7

GOLD - metal (refined) 3.7 2.7 1.5 0.5 2.2 2.0

         

33

Unrefined

EBIT (“accounting” depreciation)

/Gross revenue = X

Y = 0.5 + X/9.0 (Max = 7.0) 2002 2003 2004 2005 2006 Average

DIAMONDS 5.3 3.1 3.3 4.8 5.7 4.4

MANGANESE 5.3 4.8 3.3 5.4 4.5 4.7

IRON ORE 4.2 3.0 2.5 5.1 6.0 4.1

MINERAL SANDS 5.1 3.6 2.2 2.3 3.3 3.3

PGM - Concentrate 4.6 2.8 2.8 2.8 4.8 3.6

COAL 3.0 2.0 2.0 2.4 2.0 2.3

CHROME 1.0 2.1 2.2 1.6 1.2 1.6

BASE METALS 0.7 0.5 0.5 0.5 2.6 0.7

34

Mineral Range Unit Sold at Ratio

Chrome Ore 37% 46% Cr2O3 48% 95.8%

Manganese 37% 48% Mn 50% 96.0%

Iron Ore 61 64 Fe 66 97.0%

Mineral Range Unit Sold at Ratio

Chrome Ore 37% 46% Cr2O3 34% 108.8%

Manganese 37% 48% Mn 35% 105.7%

Iron Ore 61 64 Fe 59 103.4%

Mineral Royalties

International comparison

36

Australia – New South Wales

• An ad valorem royalty of 4% the “ex-mine” value (value less allowable deductions) of minerals (except coal) is applied to high-value minerals.

• The rate of coals is as follows:• 7% of the value of coal recovered by open cut mining• 6% of the value of coal recovered by underground

mining• 5% of the value of coal recovered by deep underground

mining

37

Australia – Western Australia (1)

• Under the Mining Act, royalties are payable on all “minerals”. A mineral is defined as a naturally occurring substance including evaporites, limestone, rock, gravel, sand and clay.

• Rates:• Bulk material (subject to limited treatment) (Including

Diamonds): 7.5% of the royalty value • Concentrate material: 5.0% of the royalty value• Metal: 2.5% of the royalty value

• “concentrate” means the product of a process of extraction of metal or a metallic mineral from mineral ore that result in substantial enrichment of the metal or metallic mineral concerned”

38

Australia – Western Australia (2)

• “royalty value”, in relation to a mineral other than gold, means the gross value of the mineral less any allowable deductions for the mineral”

• “gross invoice value”, in relation to a mineral, means the amount, in Australian currency, obtained by multiplying the quantity of the mineral, in the form in which it is first sold, for which payment is to be made (as set out in invoices relating to the sale) by the price for the mineral in that form (as set out in those invoices).

39

Australia – Western Australia (3)

• “allowable deductions”, in relation to a mineral means –

(a) the amount, in Australian currency, of any reasonable costs incurred in transporting the mineral, in the form in which it is first sold, where those costs –

* are included after the shipment date by the person liable to pay the royalty for the mineral; and

* relate to transport of the mineral by a person other than the person liable to pay the royalty for the mineral, and

(b) the price, in Australian currency, paid or to be paid by the person liable to pay the royalty for the mineral, for packaging materials used in transporting the mineral, in the form in which it is first sold;

40

Australia – Western Australia (4)

• The royalty rate for gold metal produced after 30 June 2000 is 2.5% of the royalty value of the gold metal produced.

• The royalty value of gold metal produced shall be calculated for each month in the relevant quarter by multiplying the total gold metal produced during that month by the average of the gold sport prices for that month.

• “gold metal” means gold that is at least 99.5% pure.

41

Tanzania

• Mineral royalties are payable on gross revenue, less transport and sales costs (called the netback value)

• The rates are:– Diamonds 5%– All other 3%

• “net back value” means the market value of minerals FOB at the point of export from Tanzania, less –

– The cost of transport, including insurance and handling charges, from the mining area to the point of export or delivery; and

– The cost of smelting and refining or other processing costs unless other processing costs relate to processing normally carried out in Tanzania in the mining area.

• “market value” means the realized price adjusted if necessary for a sale FOB at point of export from Tanzania or point of delivery within Tanzania

• There are provisions for adjustment of this value when, in the opinion of the Minister, such value does not meet the arm’s- length standard.

• The Act also makes provision for reduction, remission or deferment of mineral royalties when the cash operating margin (gross sales minis operating costs) falls below zero.

42

Ghana

• The Mineral (Royalties) Regulations of 1986 provide for a sliding-scale type royalty that starts at three per cent for low grade ore with a maximum of twelve per cent for high grade ore.

• These percentages are based on the gross value of the minerals. The final royalty is determined by a mining company’s Operating Ratio (OR). This ratio is based on the quotient obtained by dividing the operating margin (i.e. working profit) by the value of minerals extracted during the relevant fiscal period:

• Operating ratio (%)• 0 to 30 3% (minimum)• 31 to 70 3 + 0.225 * (OR), maximum 12% (B = 4.45)• 71 to 100 12% (maximum)

• It is important to note that the statutory royalty rate is not influenced by either mineral type or mine size, but rather determined by mine profitability. This method typically results in a 3 per cent royalty rate for gold.

43

Ghana

• Where in any yearly period the operational ratio is less than thirty per centum then the difference between the actual operational cost and the operational cost that would make the operating ratio exactly equal to thirty per centum shall be added to the operational cost of the following yearly period for the purpose of calculating that periods’ operating ratio; provided that the difference to be carried forward shall not exceed the permissible capital allowance for the year of account.

• A Minerals Development Fund was created to return part of government income from mining to the communities who are affected by such activities.

• Twenty per cent of collected mineral royalties are paid into the fund that is shared between the local government authority, the land-owning authority and other communities which are affected adversely by the miming activity.

44

USA - Nevada

• The gross yield must include the value of any mineral extracted which was:

• Sold;• Exchanged for any thing or service;• Removed from the State in a form ready for use or sale;

or• Used in a manufacturing process or in providing a

service,during that period.

• Net proceeds are ascertained and determined by subtracting from gross yield the following deductions for costs incurred during that periods, and none other:

45

USA - Nevada

Net proceeds / Gross Proceeds (%)

• Less than 10• 10 to < 18• 18 to < 26• 26 to < 34• 34 to < 42• 42 to < 50• 50 or more

Rate

• 2.0• 2.5• 3.0• 3.5• 4.0• 4.5• 5.0