Mexico’s proposed tax creates uncertainty

A proposed mining tax of 7.5% on companies in Mexico and as much as 8% on those extracting precious metals is creating uncertainty in the industry about investing in a country that until now has been thought of as one of the world’s most...

A proposed mining tax of 7.5% on companies in Mexico and as much as 8% on those extracting precious metals is creating uncertainty in the industry about investing in a country that until now has been thought of as one of the world’s most attractive mining jurisdictions.

The mining tax, which some are describing as a royalty and has yet to be passed into law, would be on earnings before interest, taxes, depreciation and amortization and is part of president Enrique Pena Nieto’s goal to reform the tax base in the country.

The original proposal in April had been a royalty of 5% and many executives complain that every time the subject of a royalty is raised, the figure bandied about keeps getting higher.

“They’ve been talking about this for two years and they’ve had something like three different rates,” says John Gravelle, head of the mining group at PriceWaterhouseCoopers in a telephone interview from Brazil. “Every time they make an announcement it’s a different rate and every time it’s higher.”

What this does is it reduces confidence, creates uncertainty and increases risk, Gravelle maintains, and companies who made investment decisions based on the previous tax regime are now stuck. “Sometimes you spend billions of dollars on your mine and then overnight the tax regime changes substantially, and it’s a raw deal for the mining companies.”

For anyone not in production looking to raise money to build a mine, says Rob McEwen of McEwen Mining (TSX: MUX; NYSE: MUX), which is developing the El Gallo complex in Sinaloa, "it’s just another hurdle that you have to get over and in this market, it might stop a project.”

McEwen notes that many if not most politicians make decisions based on “looking in the rear view mirror.” So when gold is trading at US$1,900 per oz they believe that the mining companies are making money and set in motion plans for legislation. But by the time the legislation comes to pass, market conditions may have changed substantially, like they have today, “where many mines are right on the edge of profitability and closing.”

“They don’t seem to appreciate that fact,” McEwen continues. “The passage of legislation takes a lot longer – it’s almost like permitting – and it can come into effect at the wrong time ... When you see capital markets collapse after the price of metal collapses and then the flow of money all but disappears; for countries that put more punitive measures in place it just ensures that it takes a lot longer for the country’s mining industry to get up and running. They don’t realize it cuts back on exploration and on capital expansion of plants and further employment, which they’re looking for.”

Andrew Thomson, president and chief executive of Soltoro (TSXV: SOL), which is advancing a number of precious metal properties in Jalisco state, compares what is happening in Mexico now with what happened in Honduras years ago when the government made so many changes to the rules at the bottom of the market that “everyone just put their hands up in the air and left.”

Thomson says the likely result of a mining tax of the magnitude proposed in Mexico will be that many companies will simply suspend their operations. “Money is tight these days,” he continues, “and I don’t think they’ll be willing to move forward; there will be delays.”

The mining executive argues that while the government is trying to push through higher taxes to generate more revenue, it would be better off taxing the people that aren’t currently paying tax rather than raising levies on those that already are taxpayers.

“At the end of the day, 8% of nothing is a lot less than they can imagine,” he says. “If you overtax the people that are there and they get up and leave, you’re not really any further ahead of where you started.”

According to The South African Institute of Tax Professionals, "the proposed bill also includes increased penalty payments for the general rights that are currently assessed on concession holders based on the size of the property. These penalties are imposed when a concession is not being developed."

The SAIT notes in an article posted on its website that "if the concession holder has not carried out exploratory or exploitation activities in a mine during a two-year period, within the last 11 years, the concession holder would have to pay an additional 50% of the (current) right payable per hectare in terms of the concession. Further, if this situation remains unchanged after year 12, the amount payable by the concession holder per hectare would double."

Mexico-focused newsletter writer Mike Kachanovsky argues that if the 7.5% mining tax is passed into law it will have a chilling effect across the board, but says he suspects that the government may have floated a high number first in order to gauge the reaction and will probably settle on a lower number in the 2% to 3% range in an effort to look like it is willing to compromise.

He also makes the point that the government "isn’t stupid" and recognizes that some of the largest Mexican mining companies like Fresnillo (LSE-FRES), Grupo Mexico and Minera Frisco (a private company owned by telecoms billionaire Carlos Slim) are likely to push back against such a high rate. “Companies like Fresnillo and Grupo Mexico, they’re very politically connected ... they’re not going to allow a proposal that is so harmful to be accepted.”

Mexico is amongst the world’s largest metal producers, according to a 2012 study by Deloitte. At the end of 2010, the mining sector in Mexico represented more than 8% of the country’s GDP, and during that year Mexico regained the first place title in the world’s silver production while posting major production of copper, gold and zinc. According to Deloitte’s figures, Mexico’s geological potential has attracted more than 289 national and foreign companies to start new exploration projects, and in terms of attracting mining investment, ranks fourth in the world and first in Latin America.

In 2010, total investment related to the mining industry in Mexico rose by 16% to US$3.3 billion, the report stated. “Seventy percent of total exploration investment in the Mexican mining industry is made by foreign companies; however, 60% of the total production value is generated by Mexican companies.”

Letter writer Kachanovsky adds that Mexicans know first-hand what happens when you chase away foreign investment.

“If you discourage companies like Goldcorp and juniors like First Majestic and Alamos from investing and creating millions of jobs, I think the Mexican government understands they’re going to do more harm than good, so I think it’s unlikely that they’ll push ahead with such a draconian measure.”

But Karen Hooper, director of Latin America analysis at Stratfor, a geopolitical intelligence firm, argues that there’s a broad understanding amongst Mexico’s elite that the government is reaching a crisis point when it comes to its tax base. About 60% of workers in Mexico’s workforce are in the grey market and don’t pay taxes, she says, citing government statistics. Integrating those workers well enough to levy an income tax on them would be difficult and time consuming, which has left the government with a set of less than optimal choices.

“It’s a system that has worked because they have been subsidized by natural resources like oil, so they haven’t had to resort to income taxes,” she explains. “They have been able to rely on oil taxes in the past. But oil is drying up and if they are going to find more of it, they will have to invest more cash in what are becoming technologically more difficult deposits.”

At the same time, she says, value added taxes on things like food and medicine are not popular, so the government feels it needs to approach this “piecemeal through taxes, like closing loopholes, raising taxes on companies, and apparently this mining tax.”

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