1

Think Infrastructure.

Think IDFC.

Mineral Taxation in India

May 24, 2008

Nirmal Mohanty

Infrastructure Development Finance Company

2

Organization of talk

Motivation

Some reflections on mineral taxation in general

A review of India’s mineral sector and its taxation

Current reforms and way forward

3

Motivation

4

Motivation

Current Issue: States feel that they are not being adequately compensated

Rising mineral prices do not get reflected in their receipts

Assuming 7.5 % ad valorem for all iron ore, royalties would have been 6-8 times their realized levels (Hoda committee report)

States not in a position to remedy the situation

Most mineral rich states are among the poorest

Emerging issue I: Shortfall in mining investment is hurting infrastructure; Greater private investment required

Geology and tax regime are important factors in investment decisions

High tax burdens will make mineral products globally uncompetitive

Emerging issue II: Growing public concern with environmental degradation due to mineral extraction

Use of environmental resources can be with or without spillover effects

Mineral taxation impacts rates of extraction and depletion dates

5

Implicit Price Index for Minerals has Risen Sharply in

Recent Years

(1960-61 = 100)

0

1000

2000

3000

4000

5000

6000

1960

-196

1

1981

-198

2

2000

-200

1

2006

-200

7

6

Comparison between

Implicit Mineral Price Index & General Price Index

(1994-95 = 100)

0

50

100

150

200

250

300

1994-

1995

1995-

1996

1996-

1997

1997-

1998

1998-

1999

1999-

2000

2000-

2001

2001-

2002

2002-

2003

2003-

2004

2004-

2005

2005-

2006

2006-

2007

Mineral Price Index

General Price Index

7

Investment: Cyclical, Sluggish, but Picking up Lately

Investment in Mining at 1999-2000 prices; (Rs Crore)

0

5,000

10,000

15,000

20,000

25,000

30,000

1960

-196

1

1962

-196

3

1964

-196

5

1966

-196

7

1968

-196

9

1970

-197

1

1972

-197

3

1974

-197

5

1976

-197

7

1978

-197

9

1980

-198

1

1982

-198

3

1984

-198

5

1986

-198

7

1988

-198

9

1990

-199

1

1992

-199

3

1994

-199

5

1996

-199

7

1998

-199

9

2000

-200

1

2002

-200

3

2004

-200

5

Years

Series1

8

Share of Private Sector in Mining is Lower than in Overall

0

20

40

60

80

100

120

1960

-196

1

1962

-196

3

1964

-196

5

1966

-196

7

1968

-196

9

1970

-197

1

1972

-197

3

1974

-197

5

1976

-197

7

1978

-197

9

1980

-198

1

1982

-198

3

1984

-198

5

1986

-198

7

1988

-198

9

1990

-199

1

1992

-199

3

1994

-199

5

1996

-199

7

1998

-199

9

2000

-200

1

2002

-200

3

2004

-200

5

Mining

Overall

9

Rising Need for Power Investment Mean That Coal

Production and Investment Must Accelerate

Coal production has increased

@ 3% over the last 10 years

@ 5.3% in the last 3 years

Expected to increase @ 9.6% during

Eleventh Plan.

0

100

200

300

400

500

600

700

800

198

5-8

6

198

6-8

7

198

7-8

8

198

8-8

9

198

9-9

0

199

0-9

1

199

1-9

2

199

2-9

3

199

3-9

4

199

4-9

5

199

5-9

6

199

6-9

7

199

7-9

8

199

8-9

9

199

9-0

0

200

0-0

1

200

1-0

2

200

2-0

3

200

3-0

4

200

4-0

5

200

5-0

6

200

6-0

7

200

7-0

8

200

8-0

9

200

9-1

0

201

0-1

1

201

1-1

2

Milli

on

To

nn

es

Total

10

Percent of Surveyed Mining Companies That Consider

Mining Taxation Regime a Deterrent

0% 10% 20% 30% 40% 50% 60% 70%

Alberta

Alaska

Brazil

Chile

Mexico

British Columbia

Western Australia

Zambia

Tanzania

China

Indonesia

India

New Zealand

Sweden

Russia

Strong Deterrent Would not pursue investment due to this factor

Source: Fraser Institute Survey 2005/06

11

Some reflections on mineral taxation in general

12

Rationale and some key questions

A separate fiscal regime is justified because scarce exhaustible resource (like minerals) generate economic rent when extracted

resource taxation to capture rent

Some Key questions

How much to tax: Maximize immediate revenue or long-term revenue?

What instruments: What instruments adjust for price cycles?

Fiscal diversity or uniformity within the mining sector?

Who should tax: Central Government or States?

13

Evaluating a tax system

In analyzing mining taxes, it is essential to look at the complete system of all

taxes

To assess overall tax impact, the following questions need to be kept in mind:

Is there adequate return to investors?

Is there adequate revenue for the Government?

Is the tax system globally competitive?

14

A Review of India’s Mineral Sector and its Taxation

15

What is the sector worth?

Value of Domestic Production from Mining and Quarrying

1999-2000 2006-2007 2006-2007

(at 1999-00 prices) (at current prices)

Value of Output 53,016 76,269 134,638

Major Minerals 49,151 64,546 119,487

Fuel Minerals 43,306 54,935 100,598

Coal 24,485 34,098 44,147

Metallic Minerals 3,691 6,683 15,229

Iron Ore 1,924 3,851 11,646

Non-metallic Minerals 2,155 2,928 3,660

Minor Minerals 3,864 11,723 15,151

less: Inputs 11,172 17,316 32,117

less: FISIM 250 659 705

GDP from Mining 41,594 58,294 101,816

Total GDP 1,952,035 3,117,371 4,145,810

Share of Mining in GDP 2.13 % 1.87 % 2.45 %

Source: CSO

16

Revenue from Mining Sector

Producing States’ revenue

Royalty (State as owner of minerals; constitutes bulk)

Dead rent (area-based; to discourage operators to keep properties idle)

Initial application fee, annual fee payable, surface rent, sales tax, VAT, local

area tax (Panchayat Tax) and stamp duty (meagre amount)

Orissa and WB have imposed cess and surcharge on minerals in the belief that

they have taxation powers under entries 49 and 50 of List II of 7th Schedule

Pooled taxes (Center plus states, including non-producing states)

Corporate tax on mineral companies

Excise duties

Customs duties

17

Significance of Royalty in State Finances (2004-05)

Royalty (all mining) as

% of

Royalty (coal mining)

as % of

Total

revenue

Own

revenue

Total

revenue

Own

revenue

Chhatisgarh 9.6 15.5 7.7 12.4

Jharkhand 12.5 25.2 11.4 23.0

Orissa 5.6 12.0 3.7 8.0

Madhya Pradesh 3.7 6.0 2.7 4.4

Rajasthan 3.3 5.6 0.0 0.0

Karnataka 0.8 1.0 0.0 0.0

18

Current Royalty Regime in India

Major minerals: GoI fixes, but are collected and retained by states

Tax system is uniform across states

Changes in rates allowed once in 3 years (stability)

Regime moving progressively towards ad valorem

Still, 22 out of 51 attract specific rates, incl important ones like coal;

grade-wise rates for 6 (removes distortion)

Ad valorem incidence of specific rates vary from 1-2 % for iron ore to 25-35

% in case of limestone

Balance 39 items, rates vary from 1 % (mg concentrate to 20 % (gypsum)

Base & precious metals: fixed % of metal content value based on LME price

Minor minerals: States have powers to fix and collect

19

(w.e.f.)

Coal group February 1981 August 1991 October 1994 August 2002 August 2007

Group-I

Coking Coal

SG-I,II WG-I

7.00 150.00 195.00 250.00 =180+(0.05)P

Group-II

Coking Coal

WG-II,III Non-

coking

A,B

6.50 120.00 135.00 165.00 =130+(0.05)P

Group-III

Coking Coal

WG-IV, Non-

coking-C

5.50 75.00 95.00 115.00 =90+(0.05)P

Group IV

Non-coking

D,E

4.50 45.00 70.00 85.00 =70+(0.05)P

Group-V Non-

coking F,G

2.50 25.00 50.00 65.00 =55+(0.05)P

(Rs. per tonne)

Note: Where P is mean basic pithead price of run-of-mine coal and lignite as reflected in the invoice,

excluding taxes, levies etc.

Coal royalty over the years

20

An Illustration of States’ Grievance: Royalty on coal (as %

of price) declines after every revision

0

2

4

6

8

10

12

14

16

18

1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001

Non-coking

Source: Dr. Hemlata Rao

21

Current reforms and way forward

22

Moving from one royalty structure to another

Royalty Systems

Profit-based

(% of net profit)

Value-based

(% of revenue)

Quantity-based

(rate per ton)

Advantage

• Easy to administer

Problem

• Is not price neutral

• Tilts time path

• Raises cut-off grade

Advantage

• Revenue buoyancy

• Price neutrality

Problem

• No benchmark in

case of some

• Encourages under-

reporting

• Transfer pricing

(captive)

Advantage

• Less distortionary

• More equitable

Problem

• Uncertainty in yield

• Problems in

administration

• A alternate system worth exploring is profit sharing with operators as

attempted in the Petroleum Sector

23

Recommendations of Hoda Committee

Mode: Move decisively to ad valorem rates

Rates: Use Western Australian level as benchmarkRaise rates to Western Australian levels

Leave rate unchanged, if they are higher than Western Australian level

Unless the existing rates are inhibiting mining operations—in such cases lower the rates

Keep royalties on base metals, noble metals and precious stones low to encourage exploration

Base: Transaction value; should include profit element over unit cost of production

Sale price rather than pit mouth value

Sale price to be adjusted for transaction costs etc

Beware of transfer pricing by captive mines

Illegal mining: Non-bailable, cognisable criminal offence; special courts

24

Problems with proposed system

Overestimates economic rent

Ignores capital costs in resource exploitation

Desirable investment may be discouraged, especially at high tax rates

Double taxation of capital income when royalty coexists with corp. tax

Corp taxes are levies on capital income

Non-deductibility of capital costs means royalty is based on (economic rents plus

capital income)

Government has no clue on how much it can tax without dissuading

investment

25

Way forward: Production Sharing Contract (as in

petroleum)--Efficiency through Competitive Bidding

Prior to 1999

Majority of block allocation on nomination basis to ONGC and OIL.

No competition, no incentive => Sluggish investment; poor exploration

Post 1999

Allocation on competitive bidding basis with transparent bid evaluation

criterion

Private participation allowed; 100 percent FDI

Govt gives license without making any financial commitment for itself

Basis for bid evaluation: (I) financial standing and technical capability, (II)

work commitment and (III) fiscal package meaning what % of profit

petroleum to be shared with Govt.

Model production sharing contract provides fiscal stability to the investors

Quality of exploration has improved

162 blocks allocated; already invested $ 3 billion; commitment: $ 8 billion

26

An illustration of tax sharing

Freedom to sell crude at international price,

but only in domestic market)Total Revenue 100

=> Central or state governmentLess: First Charge: Royalty 10

Net Revenue 90

=> Includes exploration cost and production

cost and royalty; 100 % recoveryLess: Cost petroleum 40

Profit petroleum 50

=> Cash or kind; Split 50:50 between center

and relevant statesLess: Govt's share (@60 %) 30

Operator's pre-tax profit 20

=> Pooled (Center plus states)Less: Corp. Tax (@34%) 6

Post-tax profit 14

Note: no custom duty on imports for exploration; Tax holiday for seven years

27

NELP: Concept of Pre Tax Investment Multiple (PTIM)

Revenue

Profit Petroleum (both

of contractor &

Government)

Cost Petroleum

(includes Royalty, OPEX

and allowed cost recovery

of CAPEX)

Contractor’s take = Cost petroleum + Contractor’s share of Profit petroleum

Contractor’s net cash flow = Contractor’s take – ( Production cost (OPEX) +Royalty )

Contractor’s Cumulative net cash flow

PTIM =

Cumulative exploration & development cost

28

NELP : Sharing of Profit Petroleum

Profit share bidding (example) :

PTIM Tranches Profit Share to Government

Upto 1.5 30%

3.5 and above 80% (to be bid higher than earlier tranche )

Up to 1.5

3.5 & above

Pro

fit

Share

PTIM

29

Conclusion

Extend production sharing from crude and natural gas to all other minerals

Start with some important minerals such as coal, iron, bauxite

No sharing of profits in respect of older blocks

Ad valorem royalty to continue, albeit al lower rates

Compensation scheme in case of a state incurring loss