Copper prices reached a seven-year peak on 1 December 2020, hitting $7,719 per metric tonne amid renewed demand, attributed to factors including China’s economic rebound, and a growing appetite globally for copper-intensive clean energy technology and Electric Vehicles.
When mining companies can sell the copper they produce for higher prices, both their sales revenue and their profit margins increase, along with the amount of mineral royalty taxes (paid on revenues) and corporate income tax (paid on profits) that they pay to Governments in their host countries. High prices and healthy demand is typically a positive scenario for everyone, in which mining companies and Governments both benefit.
This is only the case when an equitable balance can be struck between the State and the Investor. If the mining tax regime in place rewards those that have risked their capital in mining and refining a resource into saleable commodities and, crucially, also enables the host country to benefit from its resource endowment, both parties do well and the economic benefits spread throughout the country. But when the right balance is not struck, there is risk of suppressed business and investment – and, with it, reduced taxes and economic activity – in a cycle of diminishment. This delicate balance is at risk in the current Zambian mineral royalty tax regime.
How does Zambia’s MRT structure operate?
Zambia’s mineral royalty taxation regime is structured around a series of tax bands, with the tax rate climbing to a new percentage point each time copper reaches a different price point, similar to the personal tax regime, where higher earnings are taxed at a higher tax rate once a certain threshold is reached. But – unlike the system applied for personal income tax – when the copper price crosses a threshold, the higher tax rate applies to 100% of earnings, rather than just to those above the relevant threshold. It’s equivalent to paying the highest possible tax rate on your entire monthly salary because you earned one or two dollars more than the income band in the tier directly beneath it.
This is illustrated below.
When the price of copper is $7,499 per tonne (the tax bracket within which an MRT rate of 7.5% is applicable) a mining company that produces 30,000 tonnes of copper will pay $16,872,750 in royalty tax on its revenue (before any costs have been deducted) of $224,970,000. Yet, a very slight upturn in the market that pushes the copper price over the threshold by two dollars to $7,501 per tonne – translating to an additional $60,000 in revenue – requires that $2,254,800 more must be paid in MRT tax.
Zambia’s regime currently penalises mining companies heavily when the market is strong. At a time when investing in copper should be particularly attractive to investors, this inequitable balance is disincentivising the channelling of capital into the development of new and existing mines. The example above demonstrates that higher copper prices in some cases do not make companies more profitable – it can actually make them less profitable.
Tax partner at KPMG Zambia, Michael Phiri, describes this as “perverse”, and urges a revisiting of the way in which mineral royalty bands operate.
“The royalty regime has led to mines fearing price increases – whereas we should all be celebrating them!”
Mr. Phiri sees the need for “a more equitable tax regime which does not necessarily disadvantage the mining companies.” According to him, if the MRT rates were structured in such a way that only the incremental increase – or, the difference – were subjected to the higher rates in the next tax band, that would be a fairer way of sharing resource revenues, he explains.
“The royalty regime has led to mines fearing price increases – whereas we should all be celebrating them!”
“The simple and fair solution would be to adopt the same incremental approach as we do for Pay-As-You-Earn tax bands. In other words, once a threshold is crossed, only the increase beyond that point should be taxed at the higher rate. So, let’s say the copper price was today $6,800, only the last $800 would be taxed at 6.5%. This would mean that both the State and investor benefit from the price rise, which is the balance we must inject into our mineral royalty tax regime.”
The system that he – and many other taxation experts, economists and financial brains – propose is a “sliding scale”: a structure that, as within income tax, provides for progressive or incremental increases in tax payments.
The motivation for implementing such a system goes far beyond removing penalties for mining companies, in terms of the amount of tax they are required to pay. At the heart of this issue is Zambia’s need to attract the new investment needed to further develop the industry, and kickstart the economy back to life. The prospect of increased copper demand, amid limited current supply, has the world’s miners betting on high prices and looking for new mining opportunities. Yet Zambia’s current MRT regime turns these advantageous conditions for investment into a serious disincentive.
Risks versus rewards
Mr. Phiri points out: “we are operating in a global economy where these tax rates are compared against other competitive advantages [elsewhere].”
This is, perhaps, the crux of the challenge that we face: investors always carefully seek a balance between risk and return, and decide where to invest accordingly. The risks associated with investing in Zambia currently outweigh the rewards.
Copper mining jurisdictions around the world are now riding a wave of optimism, secure in the knowledge that growing demand for clean energy technology and Electric Vehicles – coupled with the upturn in copper price – will strengthen their economies, driving the post-COVID-19 recovery that much of the world urgently needs. Countries like Peru, Chile, Panama and the DRC are attracting new investment which is being put to work building new mines and expansion projects in order to prepare for the growing market for copper. Policies that incentivise investment and growth are desperately needed at home in Zambia.
Currently, Lubambe, for instance, has a large high-grade undeveloped copper project, containing nearly 10 million tonnes of copper, while First Quantum Minerals (FQM) has announced a 70% increase in the now identified mineral reserve of Kansanshi mine. This directly opens up the possibility of the long-awaited S3 expansion project at the mine – but only if the conditions are right. With a decisive change in the general investment environment, Zambia could set in motion a new, long-term source of tax revenue (both in the form of MRT and corporate income tax), job creation, and a series of dramatic multiplier effects in Northwestern Province, last seen from 2010 onwards during the construction of FQM’s mine at Kalumbila.
The long-term consequences are an undercapitalised, under-invested mining industry, which will drive investors in the opposite direction: to other jurisdictions that will benefit from the same market that Zambia misses out on.
The mining sector has more potential than any other sector to drive a post-COVID recovery. If we focus only on short-term returns and neglect to nurture the development of mining projects that will sustain Zambia – and our future tax revenues – well into the future, we are, in Michael Phiri’s words, “shooting ourselves in the foot”.
See also: Are we prepared to play the long game?
The reality is that as the Bank of Zambia allows for “one hundred per foreign currency retention” it means that the mining firm that produces the 30,000 tons of copper at US$7,499 earns directly US$224,970,000. This US$224,970,000 goes directly into their accounts usually outside Zambia. Then what real foreign earnings that come to Zambia is the mineral royalty tax US$16,872,750. It is this US$16,872,750 that the Zambian economy has access which in effect determines the price of foreign exchange. What can top up on this figure is tax and domestic costs when the mines have to convert their US dollar revenue to pay domestic costs. In effect the access to all the foreign currency generated by Zambia is restricted.
Zambian firms are buying foreign currency based on mining costs not on the country’s capacity to generate foreign currency to which they have the RIGHT to access through the money markets.
. As recorded on page four (4) of the Economics Association of Zambia (EAZ) Memorandum to the National Assembly Committee on Economic Affairs and Labour on “The Kwacha Appreciation” held on April 26th 2006, page four (4) under the section “a. Causes of the Kwacha Appreciation” point eight (8),” it writes, “the Bank of Zambia has reported that sales of forex by mining companies increased from US$2-3 million per week in early 2005 to about US$8 million per week in November 2005, presumably in response to the wage settlement agreed earlier in 2005, and to finance local costs of their large investment programme.”
This has to be weighed against total copper revenue obtained and what was released onto Zambia’s money markets for ordinary Zambians and non-exporters to buy.
As by the 27th of April 2006 copper prices reached about US$7,500 per ton, and that Zambia exports on average about 30,000 tons of copper a month.
It meant that Zambia earned about US$225 million in a month or US$56.25 million a week, but the Zambian economy only had access to about US$8 million a week.
At US$5,000 per ton of copper on average, Zambia earned about US$150 million a month and US$37.5 million a week, which has to be weighed against just only US$8 million entering the Zambian money markets.
In effect for every one US dollar sold into the Zambian money markets US$4.68 left the country and did not enter Zambia’s markets.
Taking the exchange rate under these conditions to be at K3,200 per US dollar, the ratio applied to the exchange rate, if all the foreign currency entered the market, it would have surfaced at a minimum of about K682 per US dollar (KR0.68 ngwee per US dollar) excluding imports, that would make the Kwacha depreciate.
Therefore Tax partner at KPMG Zambia, Michael Phiri, has to see that Zambia did not have the full mines revenue pass through its money markets being but just US$16,872,750 with other mine domestic costs not included. Therefore you cannot use PAYE formulas as proposed because the mines are not earning Kwachas for their produce like most Zambians and non exporting Zambian firms. The PAYE formula can only work if the Bank of Zambia directive towards foreign currency retention changes from “100 percent foreign currency retention through exports” to “100 PERCENT FOREIGN CURRENCY RETENTION THROUGH KWACHA PURCHASES”.
Therefore Mr. Phiri has to see that there is a dual exchange rate in Zambia. One rate is bars of copper for US dollars and the other that most Zambians use is Kwachas to buy US dollars.
The playing field is not level and the mines through the Bank of Zambia directive have access to all of Zambia’s foreign currency while its citizens are reduced to beggers including the government that couldn’t pay a US$42 million installment on the Euro bond because the mines is shipping all of Zambia’s foreign currency as some one at the Bank of Zambia and Finance Ministry has allowed it in return for most probably kickbacks.
Don’t forget Mr. Phiri the LME copper price is just one mechanism to selling copper.
As noted as late as April 1966 Roan Selection Trust (RST) and Anglo American Corporation (AAC) sold Zambian copper at £336 per ton under a producer price system, while the LME price was at £753 per ton.
Then the 1966 economic growth rate was robust, well above seven per cent and a strong Kwacha parity existed, US$2.80 per Kwacha.
Today however, in contrast, when LME copper prices drop, Zambia’s economic growth rate is negatively affected, including the exchange rate parity.
Consequently, the reasoning that arises from this is that low copper prices do not spell economic doom under the producer price system, as opposed to the LME price system in which low copper prices spell an economic catastrophe.
Originally local mines using the producer price system faced political pressure to use the LME pricing system.
Thus the LME price system came into effect on April the 25th 1966 as reported by the Times of Zambia that, “The Minister of Finance, Mr. Arthur Wina, has announced that a new export tax is to be imposed on all copper export leaving Zambia with effect from mid-night tonight.
Mr. Arthur Wina’s announcement follows the decision by Zambia’s copper producers to revert to selling their copper at London Metal Exchange prices.”
When comparing the two pricing mechanisms, a large difference exists.
On the producer price system its money market liquidity is small, as Zambian copper then was sold in Rhodesian pounds whose total liquidity was small, hence it is easily influenced by US dollar inflows as compared to the large existing liquidity of the London money markets.
As observed, under the producer price system, US dollar inflows into the Zambian economy in 1966 faced a total of Zambian Kwacha (Rhodesian pounds) currency in circulation of K32.7 million and Zambia’s foreign exchange inflows reached US$520 million (exports) minus imports.
Therefore US$520 million would have to purchase K32.7 million (excluding other needs for the Kwacha locally) to buy Rhodesian pounds needed to buy “discounted” Zambian copper, ( “discounted” as it is below the LME price).
Thus the increasing availability of US dollars within the Zambian money markets looking for Rhodesian pounds (later the Kwacha) this exceeded the available Rhodesian pounds liquidity and hence Zambia could achieve an exchange rate of about US$2.8 per Kwacha.
Added to this, any Zambian could travel with Kwachas abroad and have them changed into any international currency as they was a demand for the Kwacha as the Kwacha could be used to directly purchase Zambian copper at a cheaper price lower than the LME price.
The LME only sells in US dollars, Sterling pounds, Euro, Japanese Yen and recently the Chinese Renminbi.