The energy transition is driving a surge in demand for critical minerals used in low-emission technologies, presenting new revenue opportunities for resource-rich countries. However, capturing these revenues is not straightforward, in part due to the complexity of mining operations.
A mining company may engage simultaneously in exploration, mining operations, and commodity trading, either within a single jurisdiction or across multiple ones. The tax treatment of income and expenses related to these varying activities can affect the timing and quantum of tax collected. Should governments treat the profits and losses from the different activities all together, or assess each activity or project separately?
Ring-fencing is a policy choice under which countries create a fiscal fence around a project or activity, so that each one is taxed separately on its own. For instance, where an investor carries out other business activities in addition to the mining projects or operates across multiple stages of the value chain, e.g., production, processing, and transport, governments can introduce ring-fencing rules to prevent income and expenses from being consolidated across activities.
This is especially relevant where the tax system relies on special resource rent taxes or increased corporate income tax rates for the mineral production activities. Countries can apply this principle to tax multiple mining projects independently, ensuring that profits or losses from one project do not offset those of another.
The Benefits of Ring-Fencing
Mining companies typically invest heavily in green-field exploration and development long before production begins, as well as in brownfield exploration to expand existing mines, taking on significant upfront costs and financial risks. Without ring-fencing, losses from one project or other activity can be used to offset profits from another for tax purposes, reducing the taxable income of profitable projects, and delaying government revenues.
By requiring each project or activity to be assessed on its own, ring-fencing can:
- enable early revenue collection. It speeds up government revenues on one hand but limits investors’ tax deferrals, thus impacting cash flows and investment decisions, requiring careful balance or alternative tools, such as royalties, to achieve the early revenue objective.
- address mining tax base issues: For instance,
- preventing misuse of differential tax rates: Stops cross-activity profit/loss shifting and protects mining revenues to be taxed in accordance with the special fiscal terms.
- discouraging inflated costs and other base erosion and profit shifting (BEPS) practices: Ring-fencing reduces the incentive to overstate expenditures to gain tax benefits.
- encourage new entrants to the mining sector. It levels the playing field by preventing incumbents from offsetting new project costs against existing profits, promoting investor diversification.
The Risks of Ring-Fencing
While ring-fencing can help governments protect revenues, it also comes with trade-offs that need to be thoroughly considered:
- deterring investment. Ring-fencing prevents companies from offsetting losses across projects, including those from failed explorations. Since only a few exploration projects ever become mines, ring-fencing can discourage exploration and investment¹, as companies are unable to offset the costs of exploration projects against profits from their more profitable operations.
- creating cash flow pressures. By accelerating tax payments, ring-fencing reduces after-tax returns, which in turn impacts the ability of companies to raise capital.
- raising compliance costs. Companies must track expenses by project or activity, and tax authorities face a heavier auditing burden, especially in under-resourced administrations.
- raising administrative complexity. Tax administrations need to develop and adopt administrative processes to deal with the multiple tax bases of the single taxpayer.
When Countries Could Consider Using Ring-Fencing Rules
Whether ring-fencing delivers the benefits outlined above depends on a country’s tax system, policy goals, and administrative capacity.
A preliminary consideration is how exploration or development expenditure is treated for tax purposes. Where it is capitalized into the cost base of an asset, and deductions are spread over the asset’s useful life—the estimated period during which an asset is expected to be productive—ring-fencing may not be needed. The tax burden is already distributed over time, so companies cannot use large upfront deductions to immediately offset mining profits. But if companies can claim large deductions upfront, ring-fencing helps ensure taxes are collected fairly and revenues are predictable.
Having assessed this, countries can look at whether ring-fencing is appropriate under different taxes and policy objectives, as summarized below:
| Circumstance | Is a fiscal limit or ring-fencing appropriate? | |
|---|---|---|
| There is no differentiation of the tax rates or no special taxes for the mining sector. | Might not be necessary | There is less risk of revenue loss from cross-project offsets. Countries that allow tax base consolidation can still capture economic rents through well-designed fiscal instruments, like mining royalties. |
| Where there is a policy objective to accelerate tax revenues, and there are challenges in administering profit-based fiscal instruments. | Might not be necessary | There might be other fiscal instruments that could achieve a similar result, such as mineral royalties, which are easier to administer. |
| There is a progressive corporate income tax based on profit level, without other profit-based resource rent taxes. | Might not be necessary | Introducing ring-fencing rules could be counterproductive to the primary objective, as it may result in the application of a lower tax rate to mines with lower profit levels instead of a tax rate based on the revenue of the whole legal entity (which includes higher-profit mines). This could increase administrative burdens while providing little benefit since there are no special profit-based mining taxes to protect. |
| There are higher corporate tax rates for mining activities or special profit-based taxes for the mining sector. | Might be necessary | Ring-fencing can ensure the integrity of the special mining taxation regime; otherwise, countries risk failing to tax the specific economic rents. |
| There is a desire for early revenue collection and for levelling the playing field between new and existing investors. | Might be necessary | Ring-fencing based on a project-by-project approach may be a suitable policy option, as it prevents established companies from using profits from existing projects to offset losses from new ones, creating a fairer environment for new investors who do not have such an option. |
| There are special tax incentives granted in the mining sector (e.g., accelerated depreciation, longer loss carry-forwards). | Might be necessary | Ring-fencing may be necessary to bring forward revenues from profitable projects and prevent taxpayers from delaying taxes or engaging in BEPS practices by offsetting costs against other income. |
From Decision to Implementation
Countries that decide to move forward will face design and implementation challenges: At what level should taxes be ring-fenced? Which taxes should be covered? How should costs be apportioned? How should rules be introduced into legal frameworks?
To help countries navigate these challenges, we have developed guidance on ring-fencing design and implementation, elaborating on the considerations outlined above as well as providing recommendations on rule design, legal framework integration, and administrative requirements, recognizing that effective ring-fencing requires balancing revenue protection with investment attractiveness and administrative feasibility.
¹ In practice, investment decisions are shaped by multiple factors, and expectations of future mineral demand may continue to drive investment. This raises the question of what role ring-fencing rules will play.
² Governments may apply such special regimes for mining companies as some operations may generate higher profit due to being located on rich ore deposits or have good access to transportation infrastructure.
³ Mining tax regimes can include specific incentives to reflect the unique features of the sector, such as high upfront capital costs and commodity price volatility.
Jaqueline Taquiri is a senior tax policy advisor working for the Global Mining Tax Initiative, a component of the International Institute for Sustainable Development’s Tax and Debt Program, delivered through the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development. Tomas Balco is senior adviser in the BEPS Capacity Building Team of Global Relations and Development Division at the Organization for Economic Cooperation and Development Centre for Tax Policy and Administration.