VAT Rule 18 Analysis : The Amber Rose and Wiz Khalifa Example by Kampamba Shula

VAT Rule 18: Background and Current Affairs
Valued Added Tax Rule No. 18 has been in existence since 1997 with the intention of making Zambian exports competitive through VAT refunds on exports.
Under Rule 18, the requirement to obtain information from importers outside Zambia’s jurisdiction has proved impractical and results in delayed processing of VAT refunds.
According to a letter by Minister of Finance Alexander Chikwanda to President Michael Sata, seeking his guidance on VAT tax administrative Rule 18, he stated that the uncleared backlog with the mines was in excess of $600 million (K3.6 billion).
Against this backdrop, the Zambia Revenue Authority (ZRA) has amended Rule 18 of the Value Added Tax (VAT) General Rules of 1997 to safeguard Government revenue with effect from September 8, 2014.
ZRA commissioner general Berlin Msiska says Rule 18 affects exporters and the mining sector.
In 2013, the Zambia Revenue Authority (ZRA) amended the rule by way of Gazette Notice No. 26 of 2013 which adjusted all VAT returns to standard rate export sales until proof of compliance to the rule has been made in order for exporters to claim VAT refunds.
According to a letter written by ZACCI president Geofrey Sakulanda to Minister of Finance Alexander Chikwanda, ZACCI highlighted some of the challenges of VAT rule 18 for the minister’s possible consideration.
Mr Sakulanda outlined that prior to the 2013 amendment act, compliance to this rule had been by way of providing to the Zambia Revenue Authority ( ZRA), the documentation of invoices issued by the exporting company, duly completed export documents (Form CE20), release orders by ZRA confirming exit at the border and proof of payment into the company’s bank account.
However, Mr Sakulanda noted that the amended VAT rule 18, in part, particularly Rule 18 (1) (b), requires that in addition to the requirements above, an exporting company must also provide copies of import documents for the goods bearing a certificate of importation into the country of destination provided by the customs authority of that country as proof of export.
He argues that the amended VAT rule No. 18, has its own challenges.
Among such challenges is the requirement to produce copies of import documents for the goods, bearing a certificate of importation into the country of destination provided by the customs of that country as proof of export.
Mr Sakulanda stated that exports made to clients in the export markets on such terms that once a consignment is handed over to the client’s agents, the responsibility of the exporter is terminated and the exporter has absolutely no control over the consignment from that point and export invoices are based on the terms of sale.
“It is challenging to obtain information documents to prove importation in most of the export markets for Zambian products. This situation is even worse in one of Zambia’s key export destinations, namely Democratic Republic of Congo (DRC).
“Exporters are not in any way averse to complying with the law but need special consideration to find practical solutions to dealing with this challenge. This situation is detrimental, as it erodes competitiveness especially that our competitors in the regional markets do not require that similar documents to be produced,” Mr Sakulanda said.
VAT Rule 18: The Amber Rose and Wiz Khalifa Example (Ficticious)

(All Characters Ficticious)
A recently divorced couple by the name of “Wiz Khalifa” and “Amber Rose” have son called “Sebastian”.According to the prenupt they signed before marriage, in the case of divorce Wiz Khalifa is required to pay alimony and Child support (depending on custody court case) to Amber Rose per month. For the sake of this example, let’s put Alimony and Child support in one category and call it “VAT”.
Now according to the prenuptial, Whenever Amber rose buys stuff for their son Sebastian she is allowed to claim to be refunded (payed back) from VAT. One of the conditions in VAT is that Amber rose is supposed to provide receipts of every transaction which she buys stuff for Sebastian. This condition is sensible in theory but is a bit difficult to apply in practice. Amber rose can give her friend to take Sebastian to a movie when she is busy and her friend may lose the receipt on the way back. This makes it difficult for Amber to produce a receipt. This condition is difficult to apply so sometimes she usually doesn’t produce a receipt but still gets refunded VAT.
Sometime later, one of Wiz Khalifa’s friends tells him that he has been seeing Amber going to get a lot of expensive manicures, shopping etc. and suspects that the money is from VAT which is supposedly for Sebastian. What makes it worse is that Wiz Khalifa hears that Amber Rose has been seen chilling with a guy called Nick canon and spending money on him.This makes him angry. So this is what Wiz Khalifa decides to do, he enforces the rule that Amber has to provide receipts for every transaction on which she spends money on Sebastian. Similar to before, Amber is unable to provide receipts for some payments for Sebastian which she does through her friend. Wiz decides to hold any refunds until Amber can provide receipts of payments some of which she pays through other people who are not so mindful of the receipts. Therein lies the stale mate.
Now is Amber Rose legally entitled to refunds from VAT, yes. Is Wiz Khalifa legally allowed to withhold VAT until Amber provides receipts, yes. Now Wiz Khalifa legally has to pay Amber Rose the VAT refunds but he has a legitimate reason to ensure that Amber Rose actually spends the money on his son Sebastian.
There are two options
1. Wiz Khalifa can wait till the court case in which Amber Rose will invariably win that he has to pay her the Refunds
2. Wiz Khalifa will need to be level headed. He will legally request (subpoena) a trail of money payments from Amber Rose. This trail will detail for example which friends (yeah they get subpoenaed too) take Sebastian for a movie and where they put their receipts. Wiz Khalifa can then by form of subpoena find out exactly how much money is given to the friend for the movie and whether it corresponds to the amount Amber Rose Claims on VAT. This method is obviously harder because Amber Rose’s friend is not bound by the same legality.But unfortunately is the only logical course of action. In the long run Wiz Khalifa will have to give room for Amber Rose to find a way to comply her friends to product receipts.
Now in this story, Wiz Khalifa is the Zambian Government and Amber Rose is the Mining consortium. VAT refunds refer to the Value added tax refunds that the Zambian Government through ZRA is legally obliged to pay the Mines for exported goods. Now the condition that Amber Rose had to comply with to provide receipts for payments made for Sebastian is the condition that Mining companies must comply with by providing import certificates from the country to which they export.
The problem is that mining companies for example that sell copper to China would use a middle man in London. This middle man may use a future (financial agreement) to broker the deal. He doesn’t provide mining companies with import certificates which the buying party in China is supposed to provide.
There is a solution to this problem, Solution 2. The Zambian Government must legally request (Subpoena) all the Mining companies to disclose all the middle men they sell too. These middle men will then ALSO have to be subpoenaed to provide their end sources. The importing buyers will disclose which country they operate in and a memorandum of understanding will have to be signed with the customs authority in that country.In the long run mining companies will need to be given time and support so the can ensure that their middle men get copies of import certificates from the destination countries. It’s either this or VAT Rule 18 gets amended, Again.
As it stands now in a stalemate, the Government can either pay the Mines back the Vat Refunds or it can modify VAT rule 18 so that exports are Zero rated in the first place.But Zero rating is not really an option on the table so the Government will have to be smarter about the transparency.
That transparency is open to interpretation.

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Why Windfall tax is the Solution by N'gandu Magande (Former Finance Minister)

Windfall Tax

Recently we wrote an article explaining why we thought Windfall tax is not the solution in taxing the mines. We have had the great pleasure of receiving some feedback from the Former Finance Minister Ngandu Magande who is a proponent of windfall tax.

Filled with valuable insight, below is his line of argument which we have deemed as a very much worthy a counter balance to our approach. The choice now lies in the public not to take sides but pick information from both sides to make a better tax framework.

Windfall Tax by N'gandu Magande

2008 Budget Speech Introducing the New Mining Tax Regime

1.            Mr. Speaker, I beg to move that the House do now resolve into Committee of Supply on the Estimates of Revenue and Expenditure for the year 1^st January 2008 to 31^st December 2008, presented to the National Assembly in January 2008.

2.            Sir, I am the bearer of a message from His Excellency the President recommending favourable consideration of the motion I now lay on the Table.

3.            Mr. Speaker, over the past five years, the nation has achieved macroeconomic stability characterised by growth in the real Gross Domestic Product (GDP) in excess of 5 percent per annum, the reduction of inflation to single digit, a stable exchange rate, declining interest rates, a stable financial system, the removal of the external debt burden, and a substantial build-up in foreign exchange reserves. These achievements have resulted in notable successes in the creation of jobs and wealth, and the reduction in poverty levels.

4.            Sir, our cherished and chosen vision is to be a prosperous middle income country by 2030. This will be achieved by creating a nation of dynamic, self confident and vibrant entrepreneurs. Our foremost challenge, this year and in the medium-term, is to create the fiscal space that will allow us to marshal both human and financial resources. This will enable us to accelerate the implementation of the Fifth National Development Plan.

5.            Mr. Speaker, to realise this vision, the theme of this year’s budget is “Unlocking Resources for Economic Empowerment and Wealth Creation.”

6.            Mr. Speaker, the preparation of this Budget has benefited from broad-based consultations with various stakeholders. This is in line with this Government’s policy of openness and transparency. I, therefore, wish to express my utmost gratitude for the valuable contributions made by various organisations and individuals.

Changes to the Mining Fiscal and Regulatory Regime

144.Mr. Speaker, in my 2007 Budget Address to this august House, I proposed new tax measures for the mining sector. I also informed the nation that the Government would engage mining companies, with whom we had signed Development Agreements, as part of the process of introducing the new tax regime for the mining sector.

145.Sir, given the complexity of the mining sector, a team of experts was appointed to study this matter in great detail. The findings of the study show that:

(a)           the Development Agreements in their current form are lopsided; and

(b)          even if mining companies were to move to the 2007 tax regime, the country would still not get a fair share from its mineral resources.

146.Sir, the Government has, therefore, decided to introduce a new fiscal and regulatory regime in order to bring about an equitable distribution of the mineral wealth between the Government and the mining companies.

147.Mr. Speaker, effective 1st April 2008, the new fiscal regime for the mining sector will include the following:

(a)           The corporate tax rate will be 30 percent;

(b)          Mineral royalty rate on base metals will be 3 percent of gross value;

(c)           Withholding tax on interest, royalties, management fees and payments to affiliates or subcontractors in the mining sector will be at the rate of 15 percent;

(d)          Withholding tax on dividend will be at zero percent;

(e)           A variable profit tax of up to 15 percent on taxable income, which is above 8 percent of the gross income, will be introduced;

(f)           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;

(g)          Hedging as a risk management mechanism shall be treated as a separate activity from mining;  

(h)          Capital allowance, that is a depreciation of capital equipment, shall be reduced from 100 percent to 25 percent per year;

(i)            A reference price, which shall be the deemed arms length price, shall be introduced for the purposes of assessing mineral royalties and any transaction for the sale of base metals, gemstones or precious metals between related or associated parties. The reference price shall be the price tenable at the London Metal Exchange, metal Bulletin or any other commodity exchange market recognised by the Commissioner General; and

(j)            Capital expenditures on new projects shall be ring fenced and only become deductible when the projects start production. 

148.Mr. Speaker, the new mining regulatory framework will be provided for in the Mines and Minerals Act. The framework will also have a modern licensing system based on transparent procedures.

149.Sir, these measures are competitive, reasonable and balanced. The expected additional revenues, in 2008, as a result of these new measures are estimated at US $415 million.

Line of Reasoning

In the 2008 Budget Speech I delivered under which the windfall tax was introduced in the Zambian tax regime. I and officials took time to discuss with individual mining companies on these proposals between February and May 2008. They agreed to the tax with observations that it will take away some of their income.

The price of copper then had risen from US $2,000 in 2002 to US $7,500 in 2007 per tonne, ie less than US $1 per pound to US $3.4 per pound. Somewhere in 2008, the price rocketed to just below US $10,000 per tonne or US $4.2 per pound. Most of the mining houses had invested in the early 2000's on the basis of a projected best price of US $2.5/lb and a breakeven price of less than US$2.00/lb. These statistics were presented by both parties and discussed in our meetings in 2008. Just enquire with Chibuluma Mines whether they had a meeting with me and officials at 0930 on 6th March and at 1100 hours on 18th March 2008. The government team and mining company officials agreed that prices of over US $3/lb were a windfall to be shared by the owner/introducer of the new technology and the owner/guardian of the historical God-given copper deposits. we all realized that many mines would recover their CAPEX and other initial costs in a short time than had been projected at the beginning of the century.

Our meetings with the individual mining companies in 2007 and 2008, opened by inviting them to present their investment plans which contained estimated costs of production and anticipated income. From these numbers, both sides were aware of the break-even numbers. Each mining company had its unique set of figures. All of them were above the 18 % margin, which is the world average rate for mining operations

Variable tax was on taxable income below $2.5 per pound (lb). The windfall tax was for any additional taxable income above this threshold. They were and could not be applied on the same income. All this was explained to the companies on individual basis. On 30th June 2008, the Deputy Commissioner General of ZRA had a meeting in Chingola with Finance Directors of all mining companies. he explained the new tax and a new variation to collecting the windfall tax. They all agreed that they understood the procedure, which was given later in writing. The following is the text:

"The Commissioner General of ZRA to collect the windfall tax as a provisional tax at the lowest rate of 25 percent only, so that the mining companies are not adversely affected during the year. The full effective tax rate will be calculated at the end of the operating year and the windfall tax will then be adjusted accordingly to a maximum of 47 percent. We project that in spite of these adjustments in the collection of the windfall tax, we will still achieve a collection of around US $400 million by the end of the year."

Example Calculation of Windfall Tax

TAXES FOR A MINE PRODUCING 50,000 TONNES OF COPPER IN ZAMBIA

PARAMETERS

1. TOTAL PRODUCTION:                                                50,000 TONNES
2. PRICE PER TONNE:                                         US $7,000 LME
3. GROSS INCOME:                                            US $350,000,000
4. COST OF PRODUCTION (30 %);                     US $105,000,000
5. TAXABLE INCOME:                                         US $245,000,000
6. CORPORATE TAX (30 %);                                                                   US $73,500,000
7. MINERAL TAX (6% OF GROSS VALUE):                                             US   $21,000,000
8. WINDFALL TAX:          25% between US $2.5 but below 3.00/lb (6,000 to 7,000)

25% x 50,000 x 7,000 =           US $87,500,000

50% for every 50 cents increase above 3.00 (7,000 to 8,000)

            50% x 100,000 x (7,000 minus 7,000) = US $0

75% for every 50 cents increase above 3.5 (above 8,000)

75% x 100,000 x (7,000 minus 7,000) = US$0

I.        TOTAL TAXES:   F + G  +  H + I =   73.5 + 21 + 87.5   = US $182,000,000 =52% of Gross Income

N.B: Variable tax was on taxable income below $2.5 per pound (lb). The windfall tax was for any additional taxable income above this threshold. They were and could not be applied on the same income

The formula is mathematical and the numbers could  be changed, but the rationale of sharing the WINDFALL INCOME should be maintained. The farmer must enjoy the golden eggs while looking after the Goose as it is getting old and will soon die!

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Why Wind Fall Tax is not the Solution: The Golden Goose Example By Kampamba Shula

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

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The Profit of Zambian Mining analysed by Kampamba Shula

The Profit of Mining

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.

Last year, Mining accounted for 8% of the total GDP of the country, but more than half of the export earnings. Let’s be serious, if Zambia’s main export is copper and mining accounts for only 8% of GDP something must be very wrong here.

Now such figure gives rise to the argument that mines should be taxed more, which has recently been done as the royalty tax was doubled from 3% to 6%. But this does little to solve the problem which most of the public and some policy makers seem not understand.

The problem is twofold, firstly from the lack of Zambian equity in mining companies which has allowed foreigners to take back profits from mining operations to their own countries and the lack of vertical integration of value adding activities to the minerals we produce.

Equity

We shall deal with the ownership of the mines first. Mining companies in Zambia include Mopani, Glencore, First Quantum minerals , Konkola copper mines to name a few. Zambia consolidated copper mines; a government parastatal owns 10% in Mopani. Generally after privatization of the 1990’s Zambia sold massive amounts of equity in mining operations. The intentions of privatization where genuine, the execution left much to be desired. During this phase generous tax concessions where granted to mining companies and it is only in 2007 that the Zambian people woke up to this daylight robbery.  

Civil societies and other parties where keen to be advocating for what is termed “wind fall tax”. Windfall tax which could justifiably have its own article however is not the focus currently. But just as food for thought wind fall tax is a tax on excess profits of mining companies during boom periods. The problem with windfall tax is that it is based on the premise that things are always good, which in reality is far from the truth. Copper is currently trading at about $7,000 a tonne, which is way below its excess profitable margin.

 But I digress, back to the topic Zambians have little equity in mining most of which is owned by foreigners. When Foreigners get this money they send it back to their home countries. Now this causes two problems, firstly this distorts the exchange rate market and creates high dollar demand also making borrowing in dollars expensive. Secondly, this denies Zambia from keeping profits in the country and by function gross domestic product. Now this also deserves an article on its own but I shall not go into great depth for the following reason. Recently, this month in fact, the Honorable Minister of Finance Alexander Chikwanda introduced a statutory instrument that obliges mining companies to retain profits in the country. This like any other SI will take at least 6 months to come into full effect.

Vertical Integration

Now for those that think vertical integration is a complicated term here is the break down example. Take a farmer for example who plants potatoes and goes to sell them at the market. There is no vertical integration here. But if the farmer tell his son to cut the potatoes into slices, fry them and make chips, there is vertical integration there. Obviously the farmer will be able to make more profit selling the potatoes as chips rather than as whole potatoes.

The same example applies to Zambia and its copper production. Zambia exports copper to China as a raw material. China then manufactures copper wire cables and other electronic components which it packages and sells back to Zambia. There is no vertical integration for Zambia here. But if Zambia invests in a manufacturing base where it can transform the raw copper material into copper wire cables and other electronic components, there is vertical Integration there. As with the Farmer example Zambia will be able to make more profit after vertical integration than just selling copper as a raw material.

 

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The Zambian Mining Industry Reviewed by Kampamba Shula

The Zambian Mining Industry

Zambia plays an important role in the global copper mining industry. The country contains the largest known reserves of copper in Africa, holding 6 percent of known copper reserves in the world. The history of Zambia’s copper mining industry is one of decline followed by revival. From around 700,000 tonnes in the 1970s, copper production fell to just 255,000 tonnes in 1998 as nationalization of the mines proved counter-productive. However, since the mines were privatized in the 2000s, investment and output have revived, and Zambia is regaining its world market share. In addition, the industry is expanding geographically from its traditional base in the Copperbelt to other parts of the country, where geological surveys suggest significant deposits of copper.
Copper plays a critical role in Zambia’s economy. Historically, the performance of the Zambian economy has followed the fortunes of copper mining closely. Although the economy is diversifying, copper mining continues to account for a sizeable part of GDP and is one of the lead industries for economic growth. However, Zambia—as a country—could benefit more from the mining industry. 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. The industry accounts for 15-18 percent of GDP and exports over US$3 billion worth of copper per year, but contributes just 8 percent of total tax revenue.

The reason for the low tax-take lies in the Development Agreements that were signed by Government and the mines at the time of privatization and that gave away generous tax concessions. By early 2007, concerns about ‘resource robbery’ caused by the low tax-take were creating a public outcry, which led the Government to impose, in 2008, a new tax regime consisting of higher royalties and taxes, including a windfall tax. Many aspects of the new regime, including the windfall tax, were ultimately reversed in response to the fall in copper prices during the global financial crisis. In 2009, the Government instituted another new tax regime with an effective tax rate (47 percent) within the international range (40-50 percent). This regime was designed to increase the level of government revenues, as mines that were rehabilitated after privatization began to generate strong, positive cash flows. The new tax regime, however, was challenged by the mining industry, which argued that the invariability clauses in the original Development Agreements precluded such changes. It is worth noting that a country’s legal/regulatory environment is a key determinant for investors when they compare the attributes of different destination countries. Exploration and mining companies seek a stable, predictable and transparent regulatory environment in which the rules of the game are clearly set out and administered on an equitable basis. These characteristics are particularly important in the case of the mining industry, given the high upfront capital investment and long payback periods involved. In late-2010 the Government reached an agreement with a number of mines, and these mines have already started paying in accordance with the new regime. Negotiations continue with a few remaining mines in order to bring them into the fold of the new regime. Due to its significant footprint and the debate over its tax contributions to the country, the mining industry has remained the focus of economic and political attention in Zambia.

Industry Structure

Many of the firms involved in Zambia’s copper mining are the subsidiaries of small- to medium-sized firms (by international standards of mining companies). However, there are notable exceptions (such as Vedanta, Glencore, and the China Non-Ferrous Metal Mining Group) that are major global players. Reports suggest that these are also likely to be joined by BHP Billiton, the world’s largest mining house. Though Zambian copper mining essentially is a private industry, the Government has retained a sizeable holding of the shares of the privatized mines.

The global copper mining industry operates with a long-term perspective, and production costs and risk are critical issues. The nature of the industry requires high upfront investment, high risk and long payback periods, and this has a number of implications (see below). Production costs can differ significantly between mines, depending on the type of mine and nature of the deposit. In the mining and refining industries, with prices determined by international markets, the key determinants of competitiveness are the costs of production and transporting product to market. A mine’s cost of production is a function of the nature of the resource (the quality of the ore, its depth, etc.) and the extent to which the most accessible resources have been exploited. The depletion of resources at the older mines means that they now need to mine at considerable depth and distance from the mine head, leading to high costs. Younger mines can save on operating costs, but they have to bear the upfront investment in capital and equipment, which can be significant. In addition, the cost and productivity of inputs influence the cost of production at all mines, irrespective of the nature of the resource. If prices are reasonably attractive, the cost of inputs low and the productivity of inputs high, even older mines can earn profits. For transport costs, location relative to processing and refining facilities is the key driver of costs. The overall business environment in which the mine operates also affects costs.

Potential for Zambia

Zambia is recognized internationally as having good mineral potential. The Fraser Institute’s highly respected survey of mining and exploration companies ranks Zambia 26th out of 79 jurisdictions worldwide for mineral potential. In Africa, only the Democratic Republic of the Congo and Burkina Faso have an appreciably higher score for mineral potential. The resources available to existing mines in Zambia are estimated at 2.8 billion tonnes of ore ranging between 0.6 percent and 4 percent copper. This, together with recent successful exploration, should be sufficient to sustain even an expanded industry well into the middle of the twenty-first century. Global demand for copper is expected to remain strong. Long-term forecasts are by nature uncertain, but global demand for copper is expected to grow at around 3 percent annually, reaching 25 million tonnes by 2020. Much of the increase in demand will be driven by economic growth and urbanization in emerging economies, especially China and India. Limited global supply should support high (but volatile) prices and continued investment. Global supply of copper from known sources is expected to peak at 20 million tonnes by 2013/14 and decline thereafter, resulting in a shortfall in supply. As a result, copper prices are expected to remain high in real terms, though they will be subject to cyclical fluctuations and periodic, short-term volatility. To meet the shortfall in supply and to take advantage of high prices, the global mining industry is looking to increase investment in copper mining and refining. Good mineral potential, combined with strong demand in the global market, provide an excellent opportunity for growth in Zambia’s copper mining industry. Assuming other conditions are right (e.g. Zambia’s mines are competitive in terms of costs and productivity levels), Zambia can capitalize on its mineral potential as well as the strong demand for copper in the global market.

Cost Structure

Production costs are high, driven by high (and rising) input costs and low productivity. The Zambian mining industry has a high cost base. Nearly all operations in Zambia are in the top half of the international cost curve (see Figure below). Many of the older mines, which account for the majority of output, are in the upper quartile of the cost curve. The newer mines have lower costs but are still in the middle of the curve. The major input cost of concern is labor, which has risen dramatically in recent years and the productivity of which is well below international standards. The cost of other inputs, such as equipment, spares, fuel and other consumables is also high.

Poor infrastructure is a major constraint on competitiveness. Electric power shortages limit output and existing generating capacity is insufficient to keep pace with any significant expansion in the mining industry. The rail system is costly and unreliable. Clearing borders is slow and costly, and this compounds unnecessarily high transport costs. Zambia’s policy environment is not considered favorable. The Fraser Institute’s 2010/11 survey ranked Zambia 57th out of 79 jurisdictions in terms of policy environment. This is confirmed by the influential mining consultant Behre Dolbear which, in its 2011 report, ranked Zambia 19th out of 25 countries in terms of attractiveness to mining investment. Given the significant upfront capital investments and the long payback period inherent in the industry, the stability of the regulatory environment—in relation to taxation in particular—is crucial, and Zambia scored only 3 out of 10 on the tax regime component of the Behre Dolbear Index.

Exploration

Better availability and quality of geological survey information could facilitate new mining investment. With as much as 40 percent of the country remaining to be surveyed, it is impossible to state with precision the size and economic potential of additional copper reserves in Zambia. Without high quality and detailed survey data upon which to base exploration decisions, potential investors face greater uncertainty and must proceed on a speculative basis. Investor uncertainty is ultimately reflected in the price they are willing to pay for a license, compromising Zambia’s ability to get appropriate value for money from exploration licenses. While some data are available, the quality and level of specificity is often not sufficient to support exploration. In addition, information is often not easy to access from abroad. Higher quality and more easily available survey data are likely to attract more investment and lead to development agreements that deliver better outcomes for the Government, the mines, and the Zambian people.

The cost of electric power from the public grid in Zambia (US$0.04-0.06 per kWh) is among the lowest in the world. Periodic outages, however, are a concern for power-intensive industries like mining and refining due to the sometimes lengthy disruptions to production. Should the country again suffer frequent electric power outages as it did in 2008, mines would have to rely on a combination of grid power and costly standby diesel generation (US$0.32-0.40 per kWh), making the cost of electric power uncompetitive compared to countries with reliable supply from the grid. Even more important is the capacity of the grid to accommodate planned growth in production. Without a 40 percent or more increase in supply, availability of electricity may be the binding constraint on whether and when the industry reaches the 1 million tonne target. Assuming a constant intensity of electric power demand, the target of 1 million tonnes is likely to be achievable only when the Kafue Gorge Lower project comes on-stream in 2016. In addition, as the industry expands to new parts of the country, there is a need to extend the grid.

Greater labor productivity could improve cost competitiveness. Low labor productivity is driven, on the one hand, by increasing labor costs and, on the other, by low output per worker. For example, at Mopani, labor costs increased almost fourfold between 2003 and 2008, and now comprise just over 40 percent of costs, compared with 22 percent at Indonesia’s Grasberg mine. This is despite the fact that mining is not a labor-intensive industry. Adversarial wage bargaining and Government and social pressure has encouraged large wage increases for “insiders” (trade union members) at the expense of restricting employment opportunities for the large number of unemployed Zambians (“outsiders”).

Labor productivity is a larger concern, and in this regard Zambia lags well behind international standards. In Chile, annual production of copper per worker is almost seven times greater than in Zambia, and a difference of this magnitude cannot be explained solely by variables like scale, nature of resources and better equipment. Low productivity is in large part driven by gaps in workers’ skills that are rooted in weak technical and vocational training from industry and training institutions.

More competitive, locally-produced goods and services could reduce mines’ supply costs. Manufactured goods, equipment and consumables are expensive and/or difficult to obtain in Zambia; hence mines rely heavily on imports from South Africa and elsewhere. Due to the logistics costs, trade facilitation fees and markups associated with imports, equipment and spare parts in Zambia can cost more than twice what they would in other countries. Motivated by profit, mines are keen to source from the least-cost providers that can meet their standards of quality, quantity and reliability. The greater use of local manufacturers could theoretically reduce the import and logistics-related costs that mines currently incur. Local manufacturers, however, lack the capacity to deliver the more complex, high value- added products that account for the majority of mines’ spending at a sufficient quality to meet the needs of the mines. International mine suppliers, who can produce the required quality, have thus far not located in Zambia due to its lack of attractiveness for manufacturing and, until recently, insufficient demand from mines. As a result, the industry buys only low-value items (such as food, clothing, and non-critical services) locally, often from traders rather than local manufacturers. Developing a high-quality, high-value-added manufacturing base in Zambia that is capable of supplying reliably a number of key products to the mines, will take time and will likely not be feasible for all types of mine supplies. Nevertheless, a more efficient local manufacturing industry could ultimately reduce input costs for the mines, improve industry competitiveness over the longer term, raise the incomes of local producers, and, potentially, help create markets for the copper fabrication industry.

Transport

Almost all of Zambia’s copper is ultimately exported, exiting Zambia along the routes of the North-South Corridor which connects the Copperbelt province with the major ports of Durban in South Africa (2,600 km) and Dar es Salaam in Tanzania (1,800 km). Due to the weight and volume of copper and, in many cases, long transport distances to port, rail—which tends to be lower cost than road transport—is the preferred mode of transport in the copper industry worldwide. In Zambia, however, the railway that links the Copperbelt to Dar es Salaam and Durban commands a very limited market share. Privatization has not brought the investment and skills needed to revive a rail system that fell into disrepair under public ownership, and the system has not been extended to new mining areas. In contrast, the trucking companies that, in the absence of an effective rail system, carry the vast majority of Zambian copper to market, are relatively price competitive despite significant inefficiencies along the corridor. Trucking companies interviewed during the course of this study charge around 4.2 cents/tkm for southbound traffic from the Copperbelt to Durban and 6.7 cents/tkm for northbound traffic. The southbound price compares favorably with many other African transport corridors and countries such as China and France (5.0 cents/tkm). However, the trucking of copper does face a number of challenges that unnecessarily increase costs and transit times. Aside from inefficiencies related to border crossings (described below) the main inefficiencies in the logistics environment are related to high fuel prices, poor conditions on some road stretches, and the risk of theft of cargo.

Regulatory Environment

A new regulatory and tax regime that balanced the interests of the industry and the country could create a ‘win-win’ situation. At the root of the disagreements over the tax regime is the inability of the Government and industry to find an equitable balance between, on the one hand, the commercial interests of the industry and, on the other, the industry’s contribution to national prosperity. Such a regime needs to cover, in a clear and transparent fashion, taxation, as well as Government’s obligations to provide the macro stability, governance, infrastructure and social services that the industry needs to prosper. In exchange, the Government and public at large need assurances that the mines are in fact contributing sufficient tax revenues to support the communities within which they operate and at levels consistent with profits they receive from extracting Zambia’s natural resources. Unless such a regime is agreed upon, the industry will continue to dispute at least some aspects of the new tax regime and the growth of government revenues will be constrained. Moreover, the regime will remain unstable, thereby undermining investor confidence. A more predictable regulatory environment could increase stability and reduce risks for investors. Given the large upfront investments, long-term commitments and long investment payback horizons inherent in the mining industry, stable and predictable policies are essential in evaluating a mining project’s perceived risks and economic viability. Frequent legal and regulatory changes create an air of uncertainty for investors. Zambia’s recent history of regulatory changes (such as has been seen in relation to taxation, as discussed earlier) is a severe constraint on both new investment as well as the continued operation of established mines. Responsibility for the delivery of social services could be transferred to the Government and supported by appropriate tax contributions from mines. In Zambia, expectations for the social contribution of mines extend well beyond those typically borne by private industry. Zambian mining companies incur costs and responsibilities associated with operating schools, hospitals and clinics, and maintaining local road infrastructure. Mines serve these roles partly due to gaps in government provision but in large part due to legacy expectations of mines that developed prior to privatization. While in financial terms these costs are relatively minor, uncertainty and lack of clarity under the current arrangement is cited as a key deterrent to greater investment in the sector. Hence, there may be a need for a more explicit agreement with the Government and the public at large on an appropriate allocation of social provision responsibilities, with the Government taking greater responsibility for supplying the services and a shared understanding that the industry contributes its part through the tax revenues it provides to the Government. Such an understanding would have to be supported by mechanisms to ensure appropriate tax compliance and payment by industry.

References

F. McMahon and M. Cervantes for The Fraser Institute. April 2010. Survey of Mining Companies 2009/10.

Michael Engman. May 2010. The Role of Trade and Transport Issues in the Competitiveness of Zambia’s Copper Industry (draft)).

 

 

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