Chile’s royalty debate enters final phase

Santiago, Chile — After two years of debate, the Chilean government’s attempt to extract extra tax revenue from the country’s powerful mining industry appears to be entering the final stage.

A government bill, dubbed Royalty 2 by the local press after the failure of another bill last year, is due to enter the senate for debate after winning an overwhelming majority in the lower house.

But all could depend on what olive branches the executive holds out to its supporters, who are concerned the bill could hurt locally owned mines as well as large multinational operations.

If approved, the government bill would levy up to 5% of operating income from metallic mining companies with sales of 8,000 annual tax units (roughly US$5 million today) or more, though there are some exceptions: the tax would only be imposed in full on mines with operating margins of 8% or more, and a sliding scale of payments would be used for those who fall short.

Meanwhile, mining companies operating under Chile’s DL 600 foreign investment rules, which guarantee a period of tax invariability (generally 15 years) in exchange for a higher 42% profits tax against the regular rate of 35%, will be offered the opportunity to switch to the lower rate and another 12 years of tax invariability in exchange for paying the new tax at a maximum rate of 4% rather than 5%.

The government says this system offers both protection for smaller, more-marginal operations and a fair deal for those foreign-owned companies that thought their investment charter with the government would protect them from new tax initiatives such as this one.

According to Finance Minister Nicolas Eyzaguirre, the new period of tax invariability and paying at a lower rate add up to an offer they cannot refuse.

Others are less sure.

At a recent conference in Santiago, Thomas Keller, CEO of Compania Minera Dona Ines de Collahuasi, in northern Chile, said a company’s decision to sign up for the new invariability period would depend on the maturity of the project, the length of time left to run on the existing deal, and expected dividends. (Falconbridge [FL-T] and Anglo American [AAUK-Q] control Collahuasi, which is one of the largest mines operating under the DL600 rules).

For now, though, the large foreign mining companies operating in Chile and its representative body, the Mining Council of Chile (chaired by William Hayes, executive vice-president, U.S. and Latin America, for Placer Dome [pdg-t]), has kept relatively quiet. Analysts say this reflects their concern to get the debate over and put an end to the uncertainty generated by two years of debate on the possible tax. This uncertainty is said to have caused Chile’s slump from first to 14th place in the Fraser Institute’s mining-investment sentiment survey.

Instead, most of the noise has come from the smaller players. According to the national mining association, Sociedad Nacional de Mineria de Chile (SONAMI), the new bill represents an unfair imposition on so-called medium-sized mines that produce anything from a couple of thousand to 50,000 tonnes of copper per year.

SONAMI argues that these mines, most of which are locally owned, have not enjoyed the protection offered by DL600; nor have they used the accelerated depreciation rule that allows many of Chile’s newest mines to put off paying during the early years of operation when they are still heavily burdened by debt.

Fernando Harambillet, chairman of one of the larger locally-owned copper miners, Punta del Cobre, condemns the proposed charge. “Royalty 2 will destroy medium-sized mining in Chile,” he says.

Medium-sized mines not only have much smaller margins than mega operations, such as Escondida or Collahuasi; their costs are also higher, and despite sky-high copper prices, many are still paying off debts from the last trough in the commodity cycle.

Medium-scale mining has often played midwife to much larger investments. Los Pelambres, Mantos Blancos and Quebrada Blanca (the latter operated by Canada’s Aur Resources [AUR-T]) all began life as much smaller operations.

The government initially dismissed such fears. According to Mining Minister Alfonso Dulanto, one of the bill’s main proponents and a former mining entrepreneur himself, the US$5-million cutoff point and sliding scale based on profit margins offer ample protection for the most financially vulnerable producers.

At a copper price of US93 per lb. (the Chilean government’s long-term forecast for the red metal), only half of the country’s dozen or so medium-sized miners would have to pay.

The minister has scoffed at suggestions that the miners require extra protection beyond these measures.

“There is no reason whatsoever to exclude the middle-sized miners from this tax,” Dulanto said in April. “They are not small businesses.”

Privately, officials say the government has concerns about the implications of absolving medium-sized mining companies of the proposed charge.

Lifting the bar higher will have little impact on the taxes raised: the government estimates the medium-sized miners would pay just a few million of the US$250 million the tax is set to raise each year. But their inclusion would be crucial if the mining industry decided to challenge the law in court. Chile’s 1980 constitution prohibits “irrational discrimination” between investors, and if the tax affected only the giant multinational operations, the mining companies could argue that the law displays a prejudice against foreign investors.

These arguments, both public and private, were enough to see the bill through the chamber of deputies, where it was approved by 86 votes to 14, winning approval both from government supporters and the right-wing opposition.

But the senate could be a tougher fight. Ministers have held numerous negotiations with members of centrist Christian Democracy, the largest party in Chile’s ruling coalition, who want to widen protection for the medium-sized miners. The senators have proved more intransigent than the deputies (the government lacks the majority it enjoys in the chamber), and after four weeks of talks, the government has appeared to cede on the need to raise the bar on the new charge.

Meeting last week with senators in the congress at Valparaiso, Dulanto and Eyzaguirre said they were preparing modifications to the bill but that these would be only be unveiled at a later stage, once the senate had approved the tax in its current form.

The senators may or may not go along with the government’s deal. SONAMI chairman Alfredo Ovalle says he still hopes to win serious concessions over the bill when he meets with the senate’s mining committee in May.

— The author, a freelance journalist specialized in mining, is based in Santiago.