Fiscal Stabilization, Hedging, Metals Streaming, and Ring Fencing
IGF guidance is forthcoming on these topics.
Fiscal stabilization clauses can be used in ways that are problematic from a tax perspective, as they can freeze the fiscal terms in the law or contract at the time a project begins so that changes in tax law may not be applicable to existing mines. This may result in lower-than-optimal revenues for governments over the life of a project and may help enable aggressive tax strategies by precluding government capacity to respond to them.
Fiscal stabilization clauses may be found in mining contracts, investment laws, and mining-related tax laws. They may, therefore, be project/sector specific or apply to all foreign investments. Clauses can vary significantly in form and scope. The scope, duration, and application, of stabilization clauses are implicated in a growing number of disputes between mining companies and governments. One such arbitration recently led to an award against the Government of Nigeria of more than USD 2 billion.
- IISD – Stabilization in Investment Contracts: Rethinking the context, reformulating the result
- IISD – Model Mining Development Agreement: Transparency template
- Commonwealth Secretariat, ICMM – Minerals Taxation Regimes: A review of issues and challenges in their design and application (page 33)
- OECD – Guiding Principles for Durable Extractive Contracts (paragraph 54)
Hedging is a legitimate business practice in many commodity markets. It consists of locking in a future selling price so both parties to the transaction can plan their commercial operations with predictability. Resource-rich governments should not expose themselves to the risks of speculative foreign exchange hedging operations.
A problem arises when companies engage in abusive hedging with related parties. They can use hedging contracts to set an artificially low sale price for their products and therefore record systematic hedging losses, reducing their taxable income.
Metals streaming involves mining companies selling a certain percentage of their mineral production at a fixed cost (both an upfront payment and a fixed price per unit of metal delivered) to a financier in return for funds for mine development and construction, debt refinancing, or the expansion of capital.
Since the amount of financing provided is usually linked to discounted mineral prices, companies have strong incentives to agree to lower fixed prices to increase the upfront finance available, as the financier can then sell the minerals for a higher profit. Streaming may reduce the tax base of resource-producing countries.
- The Platform for Collaboration on Tax – Supplementary Report: Addressing the information gaps on prices of minerals sold in an intermediate form
- Baker McKenzie – Metals Streaming Transactions as a Way to Raise Funds in Africa
- Canadian Mining Journal – Four Trends Driving Mine Streaming this Year
- Visual Capitalist – How precious metals streaming works
It is possible that mining companies will have multiple mining projects within a single country, creating opportunities for tax optimization using losses incurred in one project (e.g., during exploration for a new mine), to offset profits earned in another project, thereby delaying payment of corporate income tax.
In most countries, corporate income tax is generally levied at the entity level, meaning that tax rules allow mining companies to consolidate income and deductions across different projects. Ring-fencing rules are one way of limiting income consolidation for tax purposes. However, getting the design right is critical to securing tax revenues while continuing to attract further investment. In parallel, ring fencing has the potential to speed up the payment of corporate income tax, yet it may also deter further exploration and development, limiting the future tax base.