Mine rethinks strategy to meet $95m tax hit

Tax gains offset by economic impact of job losses and any production losses

Zambia’s flagship copper mine, Kansanshi, will have to find an extra US$95 million (K1.14 billion) to pay its taxes this year under the new tax regime that came into effect on January 1.

The move increases the company’s tax bill for the year to more than US$400 million from US$307 million – an amount that is already the mine’s single largest expense item.

As taxes eat into its shareholder returns and cash earmarked for capital expansion projects, the company has been forced to rethink its operational model. As a result, copper production is set to fall, bringing job losses in a downward spiral of economic degeneration.

And the country’s gains in tax revenue are likely to be cancelled out by the negative economic impact of job losses and reduced production.

After paying the Zambia Revenue Authority (ZRA) and other government agencies, the company is left with US$57 million with which to pay returns to investors – including state-owned ZCCM-IH – who face a corresponding hit of US$95 million, taking their return on investment to a woeful 4 percent.

That figure compares with a 10 percent return on investment under the previous tax system, and yields that topped 11 percent on Zambian government Eurobonds last year.

The mine has budgeted to spend US$134 million on labour for the year, US$119 million on electricity, US$112 million on fuel.

In the 12 years since it opened, from 2005 to 2017, Kansanshi has paid US$3.53 billion in taxes, spent US$3.967 billion on capital investment in the project, and paid US$151 million in dividends to 20-percent shareholder ZCCM-IH.

Since June 2018 the share price of Kansanshi’s parent company First Quantum Minerals (FQM) has more than halved from US$23 per share to less than US$10 on the Toronto Stock Exchange.

The outlook in Zambia has forced the company to rethink its business model. Plans to invest US$1.3 billion in a new pit, more machinery, a new concentrator and smelter expansion have been on hold since 2012 (when mineral royalties were doubled under the PF government from the global norm of 3% to 6%) and are now unlikely to go ahead, leading to a gradual decline in output as the lower ore grades become less economic to extract.

The additional tax received by the government of US$95 million a year is equivalent to a net present value of around US$1 billion based on a discount rate of 10 percent.

Kansanshi has announced plans to make 1,250 employees redundant, a quarter of its 5,140 staff, saving an estimated US$33 million. Using an industry-accepted economic multiplier effect of between three and five additional jobs created for each employee, the negative economic impact of the job losses is US$132 million a year – US$1.32 billion over the long term.

Applied the wider industry, this implies that the additional tax revenue generated will be more than offset by the economic loss arising from the sector’s job losses and the knock-on effects in communities. This situation is exacerbated by a reduction in production which will represent a significant loss in royalties to the Zambian treasury.

The government’s 2019 Budget includes an additional 1.5 percentage point increase on all mineral royalty tax bands, and an additional two royalty bands of 8.5 and 10 percent when the copper price exceeds US$7,500 and US$9,000 per tonne respectively. Critically, mineral royalties will cease to be deductible from corporate income tax; a measure not seen in other copper mining jurisdictions.

Other measures include the introduction of a yet-to-be-quantified sales tax to replace VAT, meaning companies cannot reclaim tax on input purchases.  This measure will beparticularly damaging to local Zambian mine suppliers. It is known that ZRA owes the Zambian mining sector in excess of half a billion US dollars in unpaid VAT refunds.

The mining industry, through the Zambia Chamber of Mines, proposes a lower increase in mineral royalty tax that will enable companies to maintain profitability. It is also calling for the MRT to continue being tax-deductible to stimulate further investment in the sector and ensure profitability during times of low copper prices.

It has been notable that the IMF, the arbiter of good taste on the Zambian economy, and scheduled to undertake an Article IV Mission to Zambia in the coming weeks, has been conspicuously absent from the tax debate.

Hits: 68