CHAPTER 2 ROYALTY PAYMENTS ON MINING IN CHILE AND PERU (ENGLISH VERSION)

• Jurisdiction: Derecho Internacional

MINING LAW & INVESTMENT IN LATIN AMERICA
(April 2003)
CHAPTER 2
ROYALTY PAYMENTS ON MINING IN CHILE AND PERU (ENGLISH VERSION)
Juan Luis Ossa
Ossa & Cía Ltda,
Santiago, Chile

1. INTRODUCTION

In recent months, some commentators in Peru and Chile have voiced the view that royalty payments should be added to the tax legislation applicable to large-scale mining operations in those countries.

There are different types of royalties. The most widely used consists of a tax applied as a percentage of gross value, either real or presumed, of the extracted ore. It is. thus, an ad valorem duty levied on production, not on profits. This type of royalty is a "blind" tax, since it does not account for the margin between costs and the prices the market will bear. Royalties are a tempting concept for any government because -in theory at least—implementation is straightforward and non-discretionary.

In Peru and Chile, mining is a gravitating factor within the economy and can be expected to continue to play a fundamental role given the array, quality and abundance of reserves in both nations. While it is true that, in global terms, mining's share of total worldwide exports has fallen from 7% in 1970 to just 3% in the mid 1990s, it is equally true that both Peru and Chile account for a sizable portion of the current total.

Major mining endeavors, in terms of their profile, are all unique. To state the obvious, mining involves the use of an exhaustible natural resource. However, since that resource is usually located underground, mining also reflects the high risk associated with exploration: estimates suggest that only one in thirty geologists will discover an economically viable deposit in their lifetimes. A second, above-average risk factor is found on the commercial end: the projects are large-scale and thus involve heavy investments with protracted maturity periods. Furthermore,

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environmental policies are increasingly strict with regard to mining in both nations, while in Peru dealings between miners and indigenous groups are also increasingly stringent.

To all of the above, we must add the factor of a certain amount of political risk -an aspect never completely absent in Latin America. Most of the companies are foreign and, to a certain extent, broad sectors of society have the erroneous notion that these firms are mining the wealth of the nation, obtaining enormous profits while paying less than their fair share of taxes.

Lastly and paramount to this introduction, as the World Bank notes, one of the four factors investors analyze in determining where to locate their mining activities is the tax system applicable to the industry in any given country.

2. HISTORICAL BACKGROUND

The concept of royalties is not new. In truth, it is an ancient idea, dating back in some aspects to the so-called "royal fifth" during the colonial era. when the Spanish crown needed precious metals and thus forced mines to operate-even if doing so was not economically profitable—in order to collect the tax. Royalties emerged at a time when tax and accounting systems were rudimentary and when governments needed desperately to collect revenue, even when the mining activities in question did not generate profits.

The modernization of tax systems, with the advent of income tax (which places the onus on profits) stripped royalties of their practical grounding.

Some 25 years ago, under the leadership of Chile and Perú, several Latin American countries began to introduce a variety of reforms into mining regulations. An effort was made to acknowledge the market as the best allocator of investments, to encourage greater protagonism among the private sector while discouraging government-led enterprises, and to introduce a clear, stable playing field for investors.

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In the area of taxes, specifically, these countries modernized their systems, setting low. neutral import duties, floating exchange rates, stable tax systems and straightforward, non-discriminatory, profits-oriented tax structures.

All of these reforms sought to inject greater...