Indigenous people and mineral taxation regimes

Pergamon PII:

Resources Policy. Vol. 24, No. 4, pp. 187–198. 1998  1999 Published by Elsevier Science Ltd. All rights reserved Printed in Great Britain S0301-4207(98)00031-2 0301-4207/99/$ - see front matter

Indigenous people and mineral taxation regimes C O’Faircheallaigh School of Politics and Public Policy, Faculty of International Business and Politics, Griffith University, Nathan, Qld 4111, Australia

Indigenous people in a number of major mineral-producing countries have established a substantial and growing capacity to tax mineral resources extracted from their traditional lands. However, almost no analysis has been conducted regarding the conceptual and practical issues involved in designing mineral taxation regimes for use by indigenous people. The general literature on mineral taxation is of limited relevance because basic assumptions it makes regarding the nature of the taxing authority (national or state governments) do not apply to indigenous peoples. This article discusses some key characteristics of indigenous communities as they relate to taxation of mineral resources. Against this background, it identifies a number of approaches to mineral taxation which might be utilized by indigenous groups and which acknowledge the specific constraints and circumstances they face while at the same time recognizing their need to attract and maintain investment on their traditional lands. It also reviews the inter-relationship between indigenous and state or governmental tax regimes.  1999 Published by Elsevier Science Ltd. All rights reserved Keywords: Indigenous people, Aborigines, taxation, royalties, resource rent taxes

Introduction During recent decades indigenous peoples in Englishspeaking countries have increasingly achieved an effective capacity to charge taxes on non-renewable resources extracted from their traditional lands.1 The circumstances in which this has occurred, and the basis on which resources are taxed, vary. In the United States, for example, some native Americans have long held sub-surface rights to lands they owned and so a legal right to tax resource extraction, but have only recently achieved the political autonomy and the economic and legal expertise to exercise that right effectively (Ambler, 1990; Royster, 1994). In other cases (for example New Zealand) judicial decisions have overturned earlier rulings limiting the impact of treaties which might otherwise have placed indigenous people in a position to extract resource taxes (Barclay-Kerr, 1991). 1

In this context taxes are defined, after Garnaut and Clunies Ross, as any charges through which indigenous people collect revenue from their mineral endowments (Garnaut and Clunies Ross, 1983, p 2).

In Australia and parts of Canada, legislation introduced during the last 20 years has provided some indigenous groups with the right, for the first time, to tax mineral extraction. Examples are the royalty provisions of the Aboriginal Land Rights (Northern Territory) Act 1976 and of Canadian comprehensive land claim settlements (Stephenson, 1997). In these countries the capacity to tax resources does not usually arise from ownership of sub-surface rights per se, as this remains with the Crown, but from specific legislative provisions. In other cases indigenous people achieve a de facto right to bargain with resource developers because their consent is required before mineral extraction can proceed or if expensive and time-consuming litigation is to be avoided. The price of cooperation by indigenous people is, increasingly, a willingness on the developer’s part to pay them significant resource taxes. This has occurred even in jurisdictions where legislation provides only for compensation for damage or loss incurred by landowners as a result of mining activity. Queensland’s Mineral Resources Act 1989, for example, explicitly rejects the concept that compensation should take any account of the existence of 187

Indigenous people and mineral taxation regimes: C O’Faircheallaigh

minerals, stating that ‘no allowance shall be made for any minerals that are or may be on or under the surface of the land concerned’ (Section 6(b)). However, since 1992, three mining companies have agreed to pay substantial royalties on mineral output as a component of agreements with indigenous landowners, and a number of others are currently engaged in negotiations which seem certain to result in similar outcomes.2 Whatever the specifics of individual cases, the general picture is clear. Indigenous people in some of the world’s largest mineral-producing countries have greatly increased their effective capacity to act as taxing entities in relation to mineral development on their traditional lands. This trend is likely to continue. For example, judicial decisions and legislative initiatives during 1992–1993 recognized, for the first time, that the native title of Australia’s indigenous people was not automatically extinguished by the establishment of British colonial rule in the late 18th and 19th centuries.3 This allows many more indigenous Australians to claim recognition of rights in their traditional lands and, where they are successful, gives them a right to negotiate in relation to future resource development activities. Neither is the trend towards greater recognition of indigenous rights confined to English-speaking or industrialized countries. For example, in 1996 PT Freeport Indonesia made its first offer of compensation to indigenous landowners affected by its copper-mining activities in Indonesia’s Irian Jaya province, where it had been operating for 25 years. A number of scholars have written about the economic and moral justification for allowing indigenous people to tax natural resources (see, for example, Altman and Peterson, 1984; Lloyd, 1983; Redhorse and Smith, 1982). Others (particularly in the United States) have considered the legal basis on which indigenous landowners may impose taxes (Royster, 1994; Stephenson, 1997; Jones, 1981; Ragsdale, 1982). There is a growing international literature which analyses the economic and social impact of resource revenues and alternative regimes for their disposition (Altman and Smith, 1994; Banks, 1994; Filer, 1991; Marshall, 1986; Morehouse and Leask, 1980; O’Faircheallaigh, 1988; Poole et al, 1992; Pretes and Robinson, 1990; Robinson et al, 1989). However, there is an almost total absence of material on the conceptual and practical issues involved in choosing or designing mineral taxation

regimes for use by indigenous people. The literature focuses almost exclusively on whether or not indigenous people should have the right to tax income from resource exploitation, on the legal basis for any such right, and on how indigenous people who do collect resource revenues utilize (or should utilize) the proceeds. It has virtually nothing to say about how indigenous people can, or should, extract taxes from resource exploitation.4 This represents an important omission, and one which increases in significance as indigenous people increase their capacity to tax mineral resources. However one regards this increased capacity, it is a fact of life and one which scholars cannot ignore if they are to fully address the issues involved in mineral taxation. There is, of course, a very large literature on how governments do, and should, tax mineral extraction, discussed briefly in the next section.5 While this literature is both extensive and sophisticated, it is often of limited relevance to indigenous peoples because the assumptions it makes about the nature and interests of the taxing authority (ie government) do not apply to them. This point is developed in the following section, which outlines some key characteristics of indigenous communities as they relate to resource taxation and argues that these characteristics necessitate a reassessment of conclusions which emerge from the broader literature on taxation of mineral resources. Indigenous communities must, like governments, seek a balance between encouraging resource exploitation and extracting revenues from it, but they also need to design tax regimes which recognize specific imperatives and constraints faced by indigenous people. The latter sections of the paper discuss a number of approaches that can be of assistance in this regard, provide a concrete illustration of how such approaches can be applied in practice and consider the relationship between indigenous and governmental taxation of mineral resources.

Indigenous people, resource development and resource taxation regimes The general literature takes as its starting point a recognition that, especially in the long term, a government’s tax yield from resource exploitation is not independent of the method of taxation used, and on this basis focuses on how governments can ‘improve the trade-off…between encouraging mining projects on the one hand and reaping large revenues from those that are undertaken on the other’ (Garnaut and

2

The willingness of developers to pay substantial resource taxes reflects their reluctance to become involved in extended litigation relating to the setting of compensation for damage or loss; and their desire to establish or maintain good relations with indigenous landowners, particularly in a political context where indigenous rights are winning increasing recognition. 3 The key judicial decision was High Court of Australia, Eddie Mabo and Others, Plaintiffs, and the State of Queensland, Defendant, 3 June 1992, F.C. 92/014. The Australian government’s major legislative response to this decision was the Native Title Act 1993.

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4 A rare and partial exception is Redhorse and Smith (1982), who offer some information on the taxation methods commonly used by US Indian tribes and comment briefly on the disadvantages associated with use of severance taxes based on mineral output or value rather than profitability (p 663). 5 For a review and extensive bibliography see Garnaut and Clunies Ross (1983). More recent contributions to the literature are Brewer et al (1989), Schantz (1994) and Hull et al (1995).

Indigenous people and mineral taxation regimes: C O’Faircheallaigh

Clunies Ross, 1983, p 1). Much of the literature is concerned with assessing alternative forms of taxation in terms of their capacity to facilitate and encourage optimum trade-offs before these goals. The major forms of taxation dealt with by the literature are of four general types; in discussing these the terms ‘taxes’ and ‘royalties’ are used interchangeably: • unit royalties, which involve the application of a flat charge to each unit of mineral produced; • ad valorem royalties, which involve the application of a percentage tax to the value of minerals extracted; • profit-based royalties, charged as a percentage of either gross profits (mineral revenues less operating costs and depreciation) or of economic rents (mineral revenues less operating costs and the supply price of capital); and • amounts fixed in advance of production, extracted either through competitive tendering processes for the right to exploit a mineral resource or through imposition of annual rentals or other set fees. There is a strong consensus in the literature that effective trade-offs between encouraging investment and reaping substantial government revenues can best be achieved by taxes that are based on profits. This is because fixed fees and royalties based on the volume or value of production tend to lead to the premature abandonment of mineral deposits, can deter investment and can fail to capture a large share of profits from highly-profitable projects (Dore, 1987; Emerson, 1982; Garnaut and Clunies Ross, 1983; O’Faircheallaigh, 1986; Palmer, 1980; Wilson, 1984). Reflecting this consensus, much recent writing on mineral taxation focuses on how profit- or rent-based taxes should be applied, rather than on whether such taxes are preferable in principle (see, for example, Cloete and van Rensberg, 1984; Brewer et al, 1989; Topham, 1991). However, a number of points distinguish the position of indigenous people, as compared with that of national or state governments, in relation to the exercise of a capacity to apply mineral taxes and suggest that the conventional wisdom may not apply in this case. Before discussing these points in detail, it is useful to review the wider impact of large-scale resource extraction on indigenous people. (What follows is of necessity a very brief overview of a complex subject; for an extended discussion and bibliography see O’Faircheallaigh, 1991.) Indigenous communities usually experience substantial social, cultural and economic dislocation as a result of resource extraction which, in many cases, occurs close to their places of residence and hunting grounds. In extreme cases this can involve the destruction of significant areas of tribal lands, largescale environmental damage and relocation of whole communities. This has occurred, for example, as a result of copper mining in Papua New Guinea and bauxite mining in north Australia. In such cases:

[indigenous people experience] severe economic, social and environmental problems: production systems are dismantled; productive assets and income sources are lost; people are relocated to environments where their productive skills may be less applicable and the competition for resources greater; community structures and social networks are weakened; kin are dispersed; and cultural identity, traditional authority and the potential for mutual help are diminished (World Bank, 1990, 4.30.2).

Even where large-scale destruction of land and removal of communities do not occur, impacts can still be very substantial. Environmental damage can reduce the availability and quality of food supplies, as occurred, for instance, from the impact of tailings disposal on fish stocks in the Ok Tedi river in Papua New Guinea. Given that hunting and fishing activities usually play an important part in social and cultural activity, the effect on food supplies is not only economic and cannot be addressed simply through provision of alternative food sources. The physical impact of mining can also have serious effects on sites or landscapes that are of spiritual significance to indigenous people. The Argyle Diamond mine in Western Australia, for instance, destroyed a Barramundi dreaming which was of great importance to Aboriginal women, while strip mining of coal in the Black Hills of Dakota damaged a landscape which was of great spiritual importance to its indigenous owners. Such damage can have social as well as spiritual implications, because of the trauma and loss of status experienced by elders as a result of their inability to protect important sites. Other adverse economic, social and cultural impacts result from the in-migration of non-indigenous people seeking employment on mining projects. These include social problems associated with greater access to alcohol; prostitution; competition for land and for employment opportunities; and the undermining of local cultural and social norms and individual self-esteem because of the impact of a dominant and often aggressive external culture. Existing social structures can also be undermined as a result of resource development, with a resultant decline in social cohesion, social control and community autonomy. For instance, new sources of income, while providing a welcome supplement to existing (and often low) cash incomes, can undermine traditional authority structures based on access to land and the knowledge required to exploit it, access which was previously vital to economic survival. Largescale resource development shifts the locus of decision-making on many important issues from the local level to central governments and the distant boardrooms of multinational resource companies. This directly undermines local autonomy and, in the longer term, can lead to a decline in the legitimacy of indigenous political structures and a withdrawal of support for them. 189

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While this discussion by no means offers a comprehensive review of the impacts of major resource projects on indigenous people, it illustrates clearly the fact those impacts can be highly negative in economic, cultural and social terms. The need to provide compensation for such damage provides a major part of the rationale for allowing indigenous people to tax resources removed from their land, or for returning a proportion of government resource taxes to indigenous landowners. Compensation may of course take forms other than tax revenues. For example, mining companies or governments may construct additional infrastructure to indigenous communities, provide land for them elsewhere or initiate special education and training programs not available to other citizens. However, in most cases, tax revenues represent a critical, if not the critical, component of the compensation package and tax is, of course, the specific focus of this paper. The discussion of project impacts raises the first point regarding the distinctive position of indigenous people in relation to the exercise of a capacity to apply mineral taxes. Given that a major objective is to compensate indigenous people for what can be very heavy social and other costs associated with largescale resource development, it may well be morally and politically unacceptable to adopt a tax regime that may fail to generate significant revenues. Highlighting this fact, during recent years a number of mines in Papua New Guinea have been subject to temporary closures, and the Bougainville copper project has effectively been destroyed, because of a belief among local indigenous populations that the benefits being generated for their communities by these projects were not sufficient to compensate for the perceived costs associated with them. A second factor which makes the position of indigenous people distinctive is that their economic and social status is often very low6. All indigenous groups in English-speaking countries receive average incomes which are well below the national average. Levels of basic services such as health, education and housing are also generally poor, and in some cases extremely poor. Low incomes and poor services are reflected, in turn, in child mortality rates which are much higher than, and average life expectancy which is much lower than, those for non-indigenous populations in the same countries. In both Australia and Canada, for example, child mortality rates are twice as high for the indigenous population as for Australians and Canadians as a whole. It is also the case that, for indigenous communities which have mineral resources on their land, exploitation of those resources often represents the only opportunity to quickly raise living standards. Against this background, indigenous communities 6

On the status of indigenous populations see, for example, O’Faircheallaigh et al (1999) (Chapter 14) and Canada, Department of Indian and Northern Affairs (1998).

190

are likely to place a very high premium on ensuring that mineral taxation regimes will guarantee delivery of at least a minimum level of revenues and one which is relatively stable. They are extremely reluctant to accept the possibility that they might miss out on revenues altogether (and so on what is possibly their only chance of raising very low living standards) if a project proves to be economically marginal. This is so even if that possibility is accompanied by an opportunity to earn very large returns on projects which prove to be highly profitable. They are also very reluctant, given that mineral revenues are likely to help fund basic services, to accept income flows which are highly volatile, since sudden declines in income could cause severe hardship to community members. A third point, which reinforces the first two, is that the capacity of indigenous peoples to spread risks across projects is often minimal. Typically a government in a major mineral-producing country or state collects revenues from scores, and in some cases hundreds, of individual projects. In this situation it can accept the possibility that a tax regime will yield little revenue from any one project, since it is likely to yield very substantial revenues from others. Any one indigenous community can extract revenue only from projects on its land and, given the small size of most indigenous communities, communities will often have only one major operating mine within their traditional territory at a given point in time. Thus a community will tend to have only one chance to extract revenue; if it fails in relation to this specific mine, it has failed in total. Taking all three points into account, a resource rent tax, for example, would be regarded as highly unsatisfactory since a mining project would yield no revenue unless it earned above-average profits. A fourth point is that indigenous communities have very little specialist administrative, information-gathering or enforcement capacity in relation to resource projects and so complex taxation regimes whose effective management requires extensive access to technical information are unlikely to be appropriate. For example, indigenous communities are likely to encounter serious difficulties in managing profitbased regimes which require monitoring of mining company outlays, current and capital, and judgments regarding the appropriateness of specific depreciation schedules. Particular problems arise when there is a need to track corporate activity across national boundaries, as where minerals are traded between various subsidiaries of multinational corporations; in cases where mineral commodities are heterogenous in terms of their physical characteristics; where it is difficult to establish an ‘open market’ price for a commodity; where multiple prices occur across different market segments; or where difficulties arise in establishing the profitability of individual mining operations. Resource rent taxes pose additional problems, requiring judgments to be formed regarding appropriate

Indigenous people and mineral taxation regimes: C O’Faircheallaigh

threshold rates of return and the appropriateness of, for instance, stockpiling policies which can affect income streams and so unrecouped expenditures, rates of return and tax liability (Grynberg et al, 1997, p 28 and 34). Similarly, systems based on competitive bidding for leases require access to a large information base and a substantial regulatory capacity in order to minimize collusion among bidders. By way of illustration of the potential problems involved for indigenous communities, Ambler (1990) and Royster (1994) describe the difficulties encountered by Indian tribes in the United States in managing royalty regimes which were not unduly complex, in part because the resources at their disposal made it extremely difficult for them to monitor either the physical activities or financial transactions of resource development companies. Indeed, the administrative capacity to support profit- or rent-based systems may be beyond the reach of smaller developing countries, let alone individual indigenous groups (see Grynberg et al, 1997 for a discussion of the constraints faced by Fiji in seeking to tax gold-mining companies). Indigenous people can of course seek to enhance their administrative capacity, in part by cooperating to share information and specialist expertise, as occurred in the United States with the Council of Energy Resource Tribes (CERT). Yet such efforts involve a cost in terms of opportunities foregone elsewhere, and in many cases the resources may simply not be available, at least initially, and the economies of scale required to achieve efficient use of specialist expertise may be absent. It is no accident that CERT was established by tribes whose lands were rich in energy resources, providing them with both the capacity and the incentive to make a substantial investment in developing their administrative and regulatory capacities. For example, on one Apache reservation oil and gas revenues generated US$25 million in 1986 alone (Ambler, 1990, p 119). Very few indigenous groups receive revenues on this scale. Another alternative is that indigenous groups can rely on government to carry out the taxing function for them, relieving them of the need to maintain relevant administrative capacity and professional expertise. This option is considered in detail in a later section. It is sufficient to note here that for legal and political reasons many indigenous groups will be reluctant to adopt it. All of these points would tend to push indigenous people towards forms of mineral taxation that are administratively simple and are likely to yield revenue irrespective of the profitability of mining investments. Such systems would emphasize fees fixed in advance of investment, unit royalties and, to a lesser extent, ad valorem royalties. They would tend to rule out profit-based systems, and in particular resource rent taxes. However, a number of factors push in the opposite direction. First, indigenous communities, like govern-

ments, need to avoid ‘killing the golden goose’, to ensure that a project proceeds, first of all, and then continues in production for as long as possible. As noted above, heavy reliance on fixed fees and on royalties not linked to profitability can have major disadvantages in this regard. Second, indigenous people wish to achieve what they regard as an equitable outcome, which means that they want to share in any significant increase in the value of minerals extracted from their land. Fixed fees and unit royalties, in particular, provide very little opportunity for this to happen. How then can indigenous people reconcile their need for certainty and for administrative simplicity with their desire to facilitate mineral extraction and gain from any increase in the value of minerals? This can only be done by modifying the basic forms of resource taxation outlined above and by creating ‘hybrid’ packages combining a number of approaches. The following section explores some options which could be helpful in this regard.

Modified unit royalties During recent years unit royalties have rarely been used in mining agreements with indigenous people (or more generally), having come into disrepute in the 1970s. This occurred both because their potentially adverse effects on efficiency and investment was recognized, and because rapid inflation and large rises in mineral prices meant that after even short periods of time the amounts of revenue they generated were insignificant compared with the value of minerals involved. However, a number of points suggest that there may now be value in considering unit royalties at least as part of a financial package for indigenous landowners. First, unit royalties negotiated in the 1960s usually made no provision for adjustment for inflation because inflation was not then an issue. It is very simple to deal with inflation by adjusting unit royalties to changes in the Consumer Price Index (CPI). Second, it is possible to take into account the possible impact of unexpected price fluctuations or other unanticipated developments. This can be done, for example, by negotiating provisions which adjust the unit royalty rate automatically to a minerals price index. The index can be calculated over an extended period of time to eliminate the impact of short-term price fluctuations but can still ensure that royalties adjust to any longer-term shift in price levels. A provision developed during one negotiation in Australia, for instance, would allow for one component of a unit royalty to adjust to a moving average of London Metal Exchange (LME) prices for the commodity concerned, with the other component moving in line with changes to the CPI. Alternatively, provision can be made to allow for a periodic review of unit royalties in the light of trends in a number of key indicators. A recent agree191

Indigenous people and mineral taxation regimes: C O’Faircheallaigh

ment negotiated between Queensland Aboriginal communities and a major multinational mining company provides for periodic review of a unit royalty in the light of factors deemed relevant by both parties, including changes in relevant commodity prices, in the relationship between trends in the CPI and in production costs for the mining operation concerned, and in the economic status of the communities concerned. Modifications of this sort help reduce two of the major problems associated with ‘standard’ unit royalties—that they are insensitive to shifts in prices and profitability, and that they do not allow the taxing agency to share in gains from any long-term increases in productivity or in the value of minerals. Third, unit royalties are very simple to administer, which, as noted above, is a major consideration for indigenous groups with limited resources. A method for verifying the physical volume of mineral output is the major requirement and this can be achieved quite easily by ensuring that indigenous landowners have a contractual entitlement to monitor and audit mineral production. The only other requirement is access to published consumer price, and possibly metal price, indices. Fourth, the income streams generated by unit royalties shift with the volume of minerals extracted, ensuring a relationship between royalty payments and the physical scale of operations. This can be a key consideration for indigenous people who, for reasons discussed in detail above, tend to be greatly concerned about the physical impacts of mining on their land and feel strongly that resource taxation regimes should recognize and compensate for them (O’Faircheallaigh, 1991). With a profit-based royalty, for instance, royalty income may actually fall as operations are expanded, especially if capital expenditure is depreciated rapidly. Finally, the income streams generated by unit royalties are usually much less volatile than other forms of royalty because they are not sensitive to short-term movements in mineral prices or to shifts in company profits. As mentioned earlier, indigenous people are likely to place a high premium on stability in revenue flows. It is significant that, for the first time in some thirty years, a recent mining agreement on Aboriginal land in Australia utilizes a unit royalty as the core of its financial package.

Modified ad valorem royalties Ad valorem royalties, calculated as a ‘flat’ percentage of the value of mineral production, are relatively simple to administer, but they have a number of significant disadvantages from an indigenous perspective. First, there is considerable uncertainty regarding the scale of future income even over the short term. Indigenous interests affected by the operation of the Ranger uranium mine in Australia’s Northern Territory have suffered severely from such uncertainty, 192

encountering major problems in maintaining service delivery functions and investments in tourist projects initiated at a time when later declines in uranium prices could not be predicted. (Ironically, the tourist ventures were initiated in part because of their perceived capacity to reduce reliance on volatile and finite mineral revenues.) Second, since the royalty rate is unaffected by changes in prices, an appropriate royalty rate must be determined in advance and usually on the basis of financial projections provided by the mining company concerned. If these projects are too conservative, indigenous people may find that royalties generate a poor return on the wealth extracted from their lands. There are also problems from a mining company perspective. While royalty liability will generally move in line with revenues, it will be entirely unaffected by costs. If costs and revenues are both rising but costs are rising more quickly, royalty liability will rise at the same time as profitability is falling. In order to reduce the uncertainty that simple ‘flat rate’ royalties create for indigenous people, they can be combined with: (1) a rental payment which is set in advance and remains unchanged as long as mining lasts; or (2) a ‘floor’ or minimum annual royalty payment which the mining company makes regardless of its actual royalty liability in any one year. While the rationale for payment of a rental usually relates to use of land rather than mineral production per se, the economic implications of rental and ‘floor’ payments are in practice similar as they both involve payments which are set in advance and occur regardless of the actual volume or value of mineral output. The advantage of both approaches from an indigenous position is that they provide a degree of certainty in relation to future income, making it easier to engage in long-term planning, to undertake long-term commitments and to avoid the economic waste and disruption associated with major swings in revenue over the short term. The degree of the advantage depends, of course, on the level at which the rental or ‘floor’ payment is set. If the rental accounts for a substantial proportion of the total financial package, the advantage is substantial; the same applies if the ‘floor’ royalty payment is set at a level close to the company’s long-term average royalty liability. From the mining company’s perspective, neither approach helps to address the possibility that the payments it makes to indigenous interests may bear little relationship to turnover or profitability. A more radical modification of the standard ad valorem royalty is to have a variable royalty rate that moves up or down in line with movements in the mineral prices around a base price. In other words, if prices fall relative to the base price, the rate at which the royalty is charged also falls; if prices increase relative to the base, so does the royalty rate. Under a flat rate ad valorem royalty, when prices fall (or rise)

Indigenous people and mineral taxation regimes: C O’Faircheallaigh

only the quantum of revenue to which the royalty is applied declines (or increases). Under a variable rate arrangement, the rate of royalty applied to the new quantum of revenue also declines (or increases). This increases the sensitivity of royalty payments to shifts in price. This general approach is expressed as: RP ⫽

CP ⫻ BRR ⫻ VMP BP

generally low levels of income and their very limited capacity to diversify their sources of income (see above). More generally, this approach would add to the volatility in income which is often a characteristic of indigenous income streams from mining activity. These problems could be addressed by: • allowing only a fraction of any price increase or price decrease to flow through to the royalty rate (for instance, it could vary by only half the percentage difference between the base and current prices); and/or by • introducing a ‘floor’ payment of the type discussed above, so that Aboriginal people would be guaranteed a minimum payment where prices declined significantly.

where RP

⫽

Royalty Payment

CP

⫽

Current Price

BP

⫽

Base Price

BRR

⫽

Base Royalty Rate

Modified profit-based royalties

VMP

⫽

Value of Mineral Production

Profit-based royalties create a number of problems for indigenous people. The first is technical, and arises from the administrative complexity involved in operating and monitoring profit-based regimes and the very high information requirements they generate, a point discussed in an earlier section. Particular problems arise where inputs for the production process are provided by, and mineral output sold to, other subsidiaries of a vertically integrated mining and processing company operating across national boundaries. In such cases it becomes both extremely difficult and very costly to track financial transactions or to reach an informed judgment regarding the appropriate price for inputs supplied by related subsidiaries of the operating company. It is possible to negotiate a resolution to some specific administrative issues. For example, one difficulty involves the treatment of non-cash costs such as depreciation and amortization. Individual mining companies vary greatly in terms of their treatment of such issues, for example because of their requirements for tax minimization or because of the nature of intra-firm transactions between parent companies and subsidiaries and between related subsidiaries. The net result is that the accounting definition of ‘net profit’ for a specific mining operation in any particular year may bear little relationship to that operation’s ‘real’ economic capacity to support royalty payments to indigenous landowners. In attempting to address this specific issue we need to distinguish between the question of which assets should be depreciated, and the issue of the rate at which assets should be depreciated. In relation to the first, if indigenous interests believe that certain assets should not be depreciated for purposes of calculating net profit, then, assuming access to mining company depreciation schedules, it should be possible to negotiate an agreed schedule of assets which are to be depreciated in calculating ‘net profit’ for royalty purposes.

An obvious issue which arises in relation to this approach involves the definition of the base price and the base royalty rate. The base price could involve, for example, a long-term historical price for the producer or product concerned. Alternatively, it could be the forecast price utilized by a project developer in making its financial projections; if the price actually realized during a particular period was above the forecast price then the royalty rate would be proportionately higher, whereas if the realized price was lower than forecast the opposite would be the case. The base royalty rate would have to be negotiated between the parties on the basis of information currently to hand in relation to the likely profitability of mining operations and other relevant factors, as currently occurs in relation to standard ad valorem royalties. This, it should be noted, would help to counteract any tendency for the developer to inflate price projections if these are used in calculating the base price, because inflated projections would make the project appear more profitable and lead to a higher level of base royalty than would otherwise be negotiated. The major advantage of a variable ad valorem rate for a mining company is that its royalty payments would reflect more directly the company’s capacity to pay (to the extent that this is determined by prices and revenues). The major advantage for indigenous interests is that a single royalty rate does not have to be set in advance on the basis of limited information about future prices, while the automatic adjustment of the royalty rate to price increases would allow them to benefit more substantially from increases in the value of minerals extracted from their land. Conversely, the impact of price falls would be greater than under a flat rate royalty, and it can be argued that indigenous people are in a particularly poor position to manage the risks associated with such a possibility because of their

193

Indigenous people and mineral taxation regimes: C O’Faircheallaigh

In relation to the rate at which assets are depreciated, two points arise. First, the application of high rates of depreciation and amortization defers, but does not avoid, liability for profit-based royalties. For example, if an asset is depreciated over five years rather than over 10, royalty payments will be lower in years 1–5 but will be correspondingly higher in years 6–10 because no depreciation allowances are available to set against profits. Thus what indigenous people forego is the notional interest on the additional royalty which would have accrued during years 1–5 if the asset was depreciated over 10 years rather than over five. The absolute level of the company’s royalty liability over the entire period is not affected by its depreciation practices. Second, assuming that a project is located in a country with a substantial and diverse mining industry, it is fairly simple to counteract the effect of any aberrant depreciation practices by calculating a ‘net profit’ based on average depreciation rates for the whole of the mining industry, rather than on those employed by the mining company involved. Taking these various points into account, a profitbased royalty could be calculated not on the basis of the operator’s standard accounting net profit but on a net profit figure calculated as follows: NP ⫽ SR ⫺ CC ⫺ (NSDA ⫻ ADR) where NP

⫽

Net Profit

SR

⫽

Sales Revenue

CC

⫽

Cash Costs

NSDA

⫽

Negotiated Schedule of Depreciable Assets

ADR

⫽

Average Depreciate Rate for the Mining Industry

However, a significant organizational capacity and information base would be required by indigenous groups simply to negotiate such ways of addressing the complex issues associated with profit-based regimes. An alternative approach for indigenous people is to capture a share of profits by taking up equity in the company developing and operating a mine, rather than to operate as a taxing agency. While this removes some of the administrative complexities and problems alluded to above, it also raises issues of its own. Most obviously, if equity is purchased indigenous people must raise the capital required, and even if they can do so there are important questions as to whether they should devote scarce resources to what are usually high-risk mining investments. If equity is provided free by the developer, there is presumably 194

some trade-off which requires, for instance, the indigenous community to forego part or all of the (more certain) income it could attain through volumeor value-based royalties. More fundamentally, profit-based royalties or equity investments, although allowing indigenous people to share more fully in the benefits generated by highly-profitable mining operations, expose them to a high degree of risk in relation to income streams, including the possibility that no profits will be generated and no royalty income or dividends will accrue. This latter outcome has in fact occurred in some cases (Holden and O’Faircheallaigh, 1995a). For this reason, profit-based royalties or equity holdings rarely form the sole basis of financial packages for mining on indigenous land. However, they can be used as part of ‘hybrid’ approaches, for example in combination with flat-rate ad valorem royalties or with ‘floor’ payments. The latter in particular would alleviate the risk imposed on indigenous landowners.

Designing tax regimes in practice: the Skardon River project In this section we seek to show how a number of approaches of the sort outlined above can be combined to create a resource taxation regime that recognizes the specific requirements of indigenous communities, while at the same time encouraging investment in resource development. In 1994 Venture Exploration N.L., a Perth-based company, wished to commence development of an integrated kaolin mining and processing project on the tribal lands of the Mapoon community, located on the western coast of Cape York Peninsula in far north Queensland. Venture planned to mine kaolin and then transfer it, in slurry form, through a pipeline to a processing plant near the Skardon River. The Aboriginal inhabitants of Mapoon were dispersed in the early 1960s when the Queensland government closed, and then destroyed, the mission at Old Mapoon. Some had returned and by the mid 1990s were rebuilding their community. Many other former inhabitants or their children were also anxious to return as soon as employment opportunities became available and basic infrastructure and services were established. During 1994 and 1995 the community prepared for and undertook negotiations with Venture, assisted by the regional Aboriginal representative body, the Cape York Land Council. As part of the preparations an extensive community consultation exercise was undertaken. This revealed that most people were supportive of the project, particularly because of the employment it was expected to generate, and that they recognized the need to design a compensation regime which would facilitate its establishment by not placing too heavy a financial burden on the project during its early years. However, there was also a strong feeling among community members that older people,

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who had borne the brunt of the earlier dispossession, should have a chance to share in income from the project before they passed away. Also relevant was the fact that mineral processing, as well as extraction, would take place on Aboriginal land. People forcefully expressed the view that the return they received should reflect the value of the processed product which left their land—a royalty should be charged not on the value of raw material extracted from the ground, as normally occurs, but on the value of products leaving the processing plant. Finally, the Mapoon community was attempting, with very limited resources, to re-establish itself on its traditional lands. From this perspective it was important to achieve a predictable flow of royalty revenues which could form the basis for longer-term community planning and development (Holden and O’Faircheallaigh, 1995b). The financial regime contained in the Venture/Mapoon agreement consists of the following components. • An ‘up-front’ sum payable on issue of the mining leases. • A relatively low royalty that applies during years 1 to 5 of commercial production, based on a fixed amount per tonne of processed output, and linked to the CPI to protect against inflation. • A higher royalty from year 6 onwards, linked to weighted average prices for processed products, but with a ‘floor’ royalty per tonne and a minimum total annual payment (the latter linked to CPI). • A free issue of equity in the project. This regime is designed to facilitate development of the project by charging only a modest and highly predictable royalty during its early years. However, it also provides some benefits for older people, by way of the ‘up-front’ payment; and seeks to ensure that the community will obtain substantial returns in later years, in part through the higher royalty and in part through its equity holding in the project. In addition and very importantly, the regime guarantees the community a specific minimum level of income as long as mining continues, providing it with some protection against depressed prices and facilitating the use of mining income in community planning and development. It should also be noted that prices of processed products, which will affect royalty payments from year 6 onwards, are less volatile than those for raw materials, which would also tend to enhance the stability of revenue flows. The Skardon River project, now operated by Australian Kaolin, commenced production in late 1998.

Indigenous taxation and government tax regimes Indigenous taxation of resource exploitation does not, of course, occur in isolation but rather interacts with

state tax regimes applied to projects on indigenous land. This raises two distinct but inter-related issues. The first involves the possibility of extracting indigenous revenues through the ‘mainstream’ tax system; the second involves the cumulative effect of state and indigenous tax regimes. It is entirely possible for the state to extract revenues from projects on indigenous land and pass these on to indigenous groups, an option which has the obvious benefit, at least in principle, of removing the need for these groups to maintain separate revenue collection, monitoring and enforcement capacities. This practice occurs in a number of jurisdictions. In Australia’s Northern Territory, for example, an amount equal to the statutory royalties charged on mines located on Aboriginal land is paid into the Aboriginal Benefits Trust Account and then expended by government or by statutory Aboriginal organizations (land councils) for the benefit of indigenous people. In Papua New Guinea, royalties collected by the national government are paid to provincial governments most of which now pass them on, in whole or in part, to the landowners directly affected by projects. However, in practice, a number of difficulties can be associated with such an approach. First, some indigenous groups (for instance in the United States) may regard reliance on federal or state governments to collect taxes as inconsistent with their status as sovereign nations and so reject this option in principle. Second, governments may seek to specify the manner in which royalties are spent, and its priorities may not be consistent with those of indigenous people. This has been a major issue in Australia’s Northern Territory. Under the relevant federal government legislation, the Aboriginal Land Rights (Northern Territory) Act 1976, amounts paid into the Aboriginal Benefits Trust Account must be distributed in a particular way, with only 30% flowing to the members of groups directly affected by mining. Forty per cent flows to the Aboriginal Land Councils which perform statutory functions under the Act, while 30% is expended, via a grants system, for the benefit of Aboriginal people throughout the Northern Territory. Not surprisingly, some groups directed affected by mining have been very dissatisfied with this system, arguing that since they incur the brunt of negative impacts they should also receive the bulk of the project taxes which are expended for the benefit of indigenous people. Even more controversial has been control over the way in which affected groups spend the 30% of royalties they do receive. The groups involved have demanded complete discretion in allocating these amounts, on the basis that since they are the ones being compensated for damage to their lives and their land, they are in the best position to decide how the money should be spent. The federal government has taken the view that the sums involved are public moneys and must be accounted for to the government 195

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and spent on the basis of policy principles it establishes. One such principle, for example, has been that royalties should be spent on community assets and infrastructure and not distributed to individuals or invested in high-risk business ventures. Aboriginal Land Councils have also sought, at times, to bring their policies to bear on spending decisions. Most groups directly affected by mining have strongly resisted these external interventions, in some cases on the basis of principle rather than because their priorities have actually conflicted with those of government or of the Land Councils. In some cases the resultant conflict has dogged the local Aboriginal organizations which receive royalties over many years. A third problem is that use of government as a taxing and revenue dispersal agent can leave indigenous groups very vulnerable to shifts in the wider political landscape. Both provincial and national governments in Papua New Guinea, for instance, have varied considerably in the extent of the sympathy they demonstrate towards local landowner interests and, correspondingly, in their willingness to maintain or enhance the flow of royalty income to these interests. In the Northern Territory the governing Country Liberal Party, which is currently seeking statehood for the Territory, has strongly opposed recognition of indigenous land rights and the payment of royalties to Aboriginal people over a period of 20 years. Indigenous people are in no doubt that their access to resource taxes will be far from assured should the Territory become a state and the Aboriginal Land Rights Act be repatriated. Fourth, each project developed on indigenous land tends to become the subject of negotiation between the developer and the particular group involved. This is inevitable given that each project is unique in terms of its impacts and that only local indigenous groups have the legal (in many cases) and certainly the moral and political authority to approve resource development on their lands. Projects also vary in their expected profitability, and so in their capacity to support imposts in addition to those applied under the state’s general tax regime. For these reasons it almost inevitably happens that, even where government has a general role as tax collector on behalf of indigenous people, additional royalties or other charges are imposed on a project-by-project basis. Such payments have been negotiated, for instance, for every mine developed in Papua New Guinea and on Aboriginal land in the Northern Territory in the 1980s and 1990s. Given that local indigenous groups are often in conflict with government over use of the revenues it does collect, or feel vulnerable to political change in relation to the continued availability of those revenues, they usually prefer project-specific payments to flow directly from resource companies to themselves. In summary, while use of governments as tax collectors for indigenous groups has superficial appeal, 196

on closer examination it appears much less attractive from an indigenous perspective. Most indigenous groups will still feel the need to devise and implement their own tax regimes. Regardless of whether they choose to do so or not, there is still the issue of the cumulative impact of state and indigenous royalties on investment in, and on the economic viability of, resource projects. Government may of course decide to forego revenue in favour of indigenous people, vacating ‘fiscal space’ so that there is no net addition to the tax burden. This has in effect occurred in relation to uranium royalties in Australia’s Northern Territory, where the federal government transfers sums equivalent to the amount it extracts as royalties to the Aboriginal Benefits Trust Account. However, few governments are prepared to forego the proceeds of mineral taxes in this way. In any case, as mentioned above, individual indigenous groups are likely to negotiate additional royalties on individual projects even where they receive revenues from government resource taxes. Thus in most cases taxes imposed by government and by indigenous people will be cumulative, and given that the latter are now often substantial this can represent a major problem for project operators and potential investors. For instance, after one indigenous community in Queensland negotiated a significant ad valorem royalty, the combined state and indigenous royalty was 8% ad valorem. For a hard rock mine this is a large impost by international standards, and certainly large enough to affect cut-off grades and investment decisions. One obvious way in which to minimize any adverse effects in this regard is to ensure that a significant proportion of the joint tax burden consists of profit taxes, which are less likely to lead to premature abandonment of deposits or to deter potential investment. However, for reasons discussed above, indigenous people are not well placed to carry the risks or the administrative burdens associated with profit-based tax regimes. Thus it is incumbent on governments, which are much better placed to spread their risks and possess relevant administrative capacity, to make greater use of profit-based royalties in their resource tax regimes. This would allow indigenous people to make at least some use of unit and ad valorem royalties while at the same time containing the distorting effects of the resource tax regime as a whole.

Conclusion As the capacity of indigenous people to extract taxes from the mining and oil and gas industries grows, the way in which they choose to apply their taxing capacity will become increasingly significant. Yet, to date, virtually no attention has been paid by scholars to the particular requirements of indigenous people in relation to mineral taxation or to how these requirements can be reconciled with the desire of many indigenous groups (and of national and state

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governments) to encourage investment on indigenous land, and with the need of resource industries to operate profitably and in a stable and predictable fiscal environment. This paper has not sought to offer definitive answers to the issues involved, but rather attempts to show that it is possible to modify existing, standard approaches to mineral taxation to better meet indigenous requirements, while at the same time recognizing the constraints and pressures facing resource developers. The alternatives suggested here may lack the neatness and intellectual attraction of some wellestablished approaches, but this is a secondary matter if they deliver taxation regimes that are viable from the perspective of both indigenous people and resource developers. The paper has also highlighted the need to deal with the cumulative impact of indigenous and state royalties to ensure that investment is not deterred and that resources can be exploited efficiently. More research is required in this area. It would be useful to document further cases where indigenous people have sought to develop specific regimes to address their particular requirements; and to identify other alternatives to the conventional approaches to resource taxation and to explore their implications for indigenous people and for resource developers. Further work is required on the inter-relationship between indigenous and state tax regimes. There is also a need to examine the extent to which modified versions of administratively simple forms of tax do actually involve efficiency losses relative to more sophisticated and administratively complex approaches, an issue that would have ramifications well beyond the area of indigenous resource taxation regimes.

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