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The Mexican government proposed earlier this month that mining companies be taxed 7.5 percent — 8 percent for those mining precious metals — up considerably from the 5 percent suggested in April.
Most people know Mexico as an oasis of sand and sun, but for those in the mining industry, the country represents a different type of abundance: resources.
Indeed, Mexico, which is known for being a mining-friendly jurisdiction, is the world’s largest producer of silver and a top 10 producer of gold, graphite, manganese and zinc, among others. However, a new royalty proposed earlier this month may be set to put a dent in those impressive numbers.
Peña Nieto takes charge
The storm has been brewing since July 2012, when Enrique Peña Nieto, leader of the Institutional Revolutionary Party (PRI), was elected president of Mexico. At the time, Silver Investing News (SIN) reported that Peña Nieto’s plan once elected was to “produce substantial economic growth on the national level,” in part by pushing for tax reform.
Although it has become increasingly common for governments to achieve such growth by using royalties to “squeeze more financial benefits from their resource sectors,” prior to the election, Peña Nieto had not identified the mining sector as a target. In fact, according to the SIN article, “a specific special tax for the mining industry” would not only be decidedly unfriendly toward investors, but also unconstitutional.
The tax arrives
Despite those barriers, in April of this year, Mexico’s Congress gave the go-ahead to a 5-percent mining royalty tax aimed at raising between US$250 million and $500 million per year. If passed into law, the bill would see a percentage of miners’ pre-tax profits be redistributed to the states and municipalities where they operate, Gold Investing News said.
Unsurprisingly, companies operating in Mexico voiced their discontent with the decision. Bradford Cooke, CEO of Endeavour Silver (NYSE:ESK,TSX:EDR), predicted in an interview with BNamericas that the royalty, along with falling gold and silver prices, would prompt foreign investors to cut their Mexican investments in half.
However, the consensus seemed to be that such complaints would not stop the bill from passing. Even the possibility of its unconstitutionality was not seen as a threat. Jorge Ruiz, a partner at law firm Baker Mackenzie, told BNamericas that once passed into law, the royalty could be legally challenged; however, he had “no doubt” that it would ultimately become a reality.
The latest development
Most recently, the Mexican government updated the April proposal of 5 percent, suggesting that miners be taxed 7.5 percent, with that amount rising to 8 percent for companies extracting precious metals, The Northern Miner reported. The tax would be on earnings before interest, taxes, depreciation and amortization.
While the original 5-percent royalty made those involved in the Mexican mining sector unhappy, the adjustment has made them downright frustrated. Expressing that annoyance, John Gravelle, head of PricewaterhouseCoopers’ mining group, told The Northern Miner in an interview, “[t]hey’ve been talking about this for two years and they’ve had something like three different rates. Every time they make an announcement it’s a different rate and every time it’s higher.”
He believes that “reduces confidence, creates uncertainty and increases risk,” all of which are deterrents for miners, especially in today’s uncertain markets.
Similarly, the publication quotes Andrew Thompson, chief executive of Soltoro (TSXV:SOL), who believes the current situation is similar to what happened in the past when the government of Honduras made a large number of changes to “rules at the bottom of the market” and “everyone just put their hands up in the air and left.”
Going full circle?
As SIN reported back in 2012, before Peña Nieto’s ascension as leader, the PRI was known as a corrupt party that maintained governance via poll rigging and coercion. In fact, Peña Nieto ran his election campaign in part on the premise that he represents “the young face of a revamped party.”
In some ways, however, he seems to be taking the country back into the past. As KPMG notes in its 2013 mining guide for Mexico, prior to the 1990s, when Mexico revoked mining-specific royalties and taxes to increase international investment, the nation’s regulatory framework was “protectionist and unfriendly to foreign mining investment.”
Those who do not want to see that type of framework make a comeback in Mexico should perhaps start hoping that Peña Nieto will stop to consider more closely his country’s history.
Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.
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