On Monday, the Parti québécois government announced a new mining royalty regime. Its hybrid proposal combines aspects from two types of royalty systems: profit based and ad valorem royalties. In this blog post, we will demystify these ways of calculating royalties in order to best analyze the government’s choice as well as what its implications are.
Let’s start with a small yet important clarification: all mining royalty regimes must deal with the cyclical nature of metal markets, which periodically increase and then decrease. When metal prices are high, mining companies naturally tend to generate more profits than when prices are low. These fluctuations obviously affect royalties.
Profit-based royalty regimes are rather simple. They levy royalties on corporate profits at the end of the year. Québec’s current regime, which has been in effect for a number of years, allows the government to claim 16% of mining companies’ profits. Such regimes have two aims:
1- To encourage the industry to invest, since as long as mining companies are only setting up shop and exploring, they do not have to pay mining royalties.
2- Not to penalize mining companies if the market price of mineral resources is low.
The regime however also brings a number of disadvantages for taxpayers, especially when resource prices are low. Furthermore, a host of tax measures in Québec ensure that mining companies pay much less royalties than they should, or that they don’t pay any at all.
Finally, when mining companies are not making any profits, they do not have to pay royalties and end up removing wealth from the ground without compensating the state. Québec’s auditor general criticized the situation by bringing attention for instance to the fact that, between 2002 and 2008, 40% of mining companies on average were not paying any royalties (p. 2-14 and 2-15). The situation did not improve in 2011, since half of operating mines in the province did not pay any royalties. Hence, this regime travesties the very essence of mining royalties, which should compensate future generations for no longer having access to the resources.
Another huge disadvantage is the fact that it is impossible for the state to keep track efficiently of the rhythm at which resources are leaving the land. Royalties should logically constitute an indication of the quantity of resource extracted, but this is not the case with profit-based royalties.
Ad valorem royalties
Ad valorem royalty regimes are also pretty simple in theory. First calculate the total value of metals and minerals the mining company extracted and then tax a percentage of this gross production value.
If, as suggests the Institut de la statistique du Québec’s estimate for 2011 (p. 6), the mining companies develop $8.2G, a 10% royalty rate on the production value would allow the province to benefit from $820M in royalties. As a comparison, in 2012, Québec received only $388M in royalties, and this was the highest amount levied in a decade.
Mining entrepreneurs consider this regime extremely disadvantageous since royalties are levied as soon as mining production occurs, without regards to profit. Hence, all operating mining companies pay royalties, even those which are operating at a loss for whichever reason.
For some, such a system would damage Québec’s “international competitiveness” as a mining jurisdiction since such a tax measure would “have a dissuasive effect” and discourage investment on the territory. However, from citizens’ point of view, it is a fairer regime which, in addition to minimally complying to the definition of what a royalty should be, gives the state a continuous income in exchange for private companies extracting and shipping public resources.
The PQ regime
The new regime tabled at the beginning of the week is a mixture of both approaches. The mining companies will have to pay the highest amount between the two following options:
A tax on the “output value at the mine shaft head” (gross production value minus certain production and transformation expenses), with a 1% rate if the output value falls below $80M and a 4% rate otherwise.
A progressive tax on the profit margin (“operator’s mining profit divided by its gross value of annual production”).
The regime should allow mining royalties to go up by 15% by 2020. The mining cycle could indeed have moved into the booming phase by then. The level of royalties will nevertheless remain below the rates which the PQ promised during the election campaign, i.e. 5% of gross production value in addition to a 30% tax on excess profit. The promised regime would have allowed to double the level of royalties.
On the plus side, the processing allowance will be enhanced to encourage the local processing of resources. To this is added a 10-year tax holiday for large investment projects, a measure which applies to primary, secondary, and tertiary processing projects within the mining industry.
Even though these are steps in the right direction, the government leaves the decision whether or not to transform in Québec within the hands of the private company. After a simple cost-benefit analysis, it will decide if the fees and tax incentives related to processing are more advantageous here or elsewhere. In contrast, requiring that a certain percentage of minerals be transformed on Québec land would have been a more efficient measure to ensure local transformation.
In the end, the PQ’s system certainly constitutes an improvement in comparison with the current regime, of which the premisses were laid in 1925. The new regime will allow the government to minimally collect royalties from all mines operating in Québec in addition to encouraging greater transparency regarding the amount of minerals extracted and the tax revenue generated. This regime nonetheless is far cry from what the PQ had promised and it ends up not being as fair as originally intended for the taxpayer.
It is also worth reflecting on how much a royalty regime reform can actually compensate for the costs associated with the environmental damage, both past and future, caused by mining activities. These costs cannot only be valued in monetary terms.
The present tax reform was obviously not aimed at questioning the suitability of Québec’s extractive model in the face of the current environmental crisis. It is nevertheless interesting to remark that the absence of such questioning in the public sphere is only symptomatic of a free mining regime: mining entrepreneurs are lords of the manor, any and all mining activities are authorized, and they considered to be the best way to use the land.
This article was written by Bertrand Schepper and Laura Handal, researchers with IRIS—a Montreal-based progressive think tank.