Windfall tax
First off before we delve into this subject we must define what Windfall tax actually is.
Windfall tax is a tax levied by governments against certain industries when economic conditions allow those industries to experience above-average profits. Windfall taxes are primarily levied on the companies in the targeted industry that have benefited the most from the economic windfall, most often commodity-based businesses (Collins, 2013).
The Problem
A combination of an excessively investor-friendly copper-mining tax regime, persistent and even tolerated tax evasion among very high income earners, a low corporate tax take generally, and the suspected purposeful neglect of taxing the gemstone sector have diminished state tax-revenue mobilization.
Firstly, Zambia does not benefit extensively from mining operations the way it should. All countries that depend on natural resources face the shared challenge of taxation: determining tax levels and administering tax revenues in an effective manner that balances the needs of Government and investors. Mining depletes a valuable natural asset and taxing the mining companies is a way of generating savings that can be redeployed to increase the productive capacity of the rest of the economy, and thereby help sustain the country over the long-term. Despite the revival of the industry post-privatization, the mining industry’s contribution to government revenues in Zambia has remained low.
Earlier this year Finance Minister Alexander Chikwanda signaled that Government was considering introducing new "tax measures" in mining to boost revenues:
"We will introduce measures and relook at the tax system in the mining sector. Our mining sector has not contributed much compared to the rest of the region. So we want to engage local experts and ensure we have the statistics on mineral production and exports, and then we will find modalities to effect new tax measures to increase revenue collection..." (Times of Zambia, 2013)
Windfall Tax
A windfall tax will be introduced to be triggered at different price levels for different base metals. For copper, the windfall tax shall be 25 percent at the copper price of US $2.50 per pound but below US $3.00 per pound, 50 percent at price for the next 50 cents increase in price and 75 percent for price above US $3.50 per pound;
Back in 2009 when the Windfall tax was still applicable the Government removed the upper 2 bands before it eventually scrapped windfall tax altogether.
Windfall is effectively a “revenue-based tax”, meaning that it is applied on the basis of gross revenue, without taking account of costs.
In addition, the windfall tax and the variable profits tax appear to duplicate each other – both being aimed at capturing that part of gross profits which is attributable to price windfalls. From an economic viewpoint, the variable profits tax is preferable, because it takes account of costs and more closely approximates value-added. However, there are concerns about the mining companies’ cost data, due to possible transfer pricing. In addition, the mines apparently reported costs for tax purposes prior to 2008 that are lower than those they claim to be incurring now. While this may well be true, it gives rise to a need to verify cost information.
Solution
ZRA’s capacity to review and verify cost information is in the process of being built up. While this is being done, there is a case for a windfall tax based on revenues. In addition, there is a strong case for independent verification of mining company cost information, and for open public scrutiny.
In 2008 the Economics association of Zambia suggested that “Government should seek to replace it as soon as possible by either the variable profits tax which would consider the cost structures of companies or structure the revenue based tax regime in such a way that the windfall tax will only apply from a price level which takes into consideration the cost structures of companies. The windfall tax should also be a flat rate. Thus the government should in the meantime re-examine the issues of tax deductibility, as well as the price thresholds and tax bands in the current legislation.”
I personally support the intentions of the general public but windfall tax as it was initially introduced in 2008 does not yet provide the stability and predictability needed to sustain investment in the mining sector.
Much of the difficulty and, indeed, suspicion surrounding mining company representations reflects concerns that they are exaggerating their costs and thereby reducing the potential tax take if taxes are based largely on profits. We know that ZRA is in the process of building up its capacity to review mining company tax returns critically, and would strongly encourage that this continue and be accelerated.
The EITI, as an internationally supported mechanism, appears to have started to help such countries as Nigeria address issues of transfer pricing in their extractive industries. The initiative is at an early stage in Zambia, and should be pursued with vigor.
The Example
A Farmer has some golden geese which lay golden eggs on his farm, he also has other geese which lay normal eggs. He keeps all the geese in the barnyard with other geese. The golden geese are very stubborn and require sensitive treatment and care; otherwise they refuse to lay as many eggs.
The farmer runs into some debt and needs to borrow money to keep his farm running. An animal care doctor comes to his aid and gives him a loan on condition that he treats the golden geese with even more care and preferential treatment than the other geese. He treats the golden geese well but to his dismay the geese (which are very smart) lays their eggs in cracks in the barnyard in which the farmer cannot reach. The geese then communicate to other geese that take those hidden eggs and go trade them for other assorted items to the Birds.
When the farmer occasionally does get some eggs, the farmer can’t price these eggs any way he would like but sells them at the market price for every ounce of gold eggs he brings. The farmer begins to get frustrated that he is not benefiting and has two options. Firstly he considers whipping and strangling the golden geese to force them to lay more eggs for him and secondly he considers covering the cracks in the barnyard to prevent the geese from sneaking out golden eggs.
He attempts to whip and strangle one of the golden geese and it dies, it lays two eggs then dies.
He tries the second option and he closes the entire cracks in the barnyard such that the geese are forced to lay the eggs out in the open where the farmer can easily pick them up and go sell them. The geese lay the Eggs and the farmer lives happily ever after.
In this story the farmer is the Zambian government, the golden goose are the mining companies. The animal care doctor is the IMF and World Bank who had the Zambian government sign very investor friendly concession in exchange for debt cancellation.
The first option of strangling the golden goose is Windfall tax.
The second option is covering tax loopholes that exist in Zambia’s current Tax laws and empowering ZRA with greater capacity to audit and tax mines properly.
It’s not rocket science to see which one is the better option.
Kampamba Shula | Economist
Economeka Capital
Posts
