Ecuadorian mining tax regime, and advances in tax incentives PDAC 2016 Strategy with substance www.woodmac.com Patrick Barnes Principal, Wood Mackenzie patrick.barnes@woodmac.com
Agenda Ecuadorian taxes overview Recent incentives and reforms Competitiveness of the Ecuadorian tax regime Questions 2
ECUADORIAN TAXES OVERVIEW Six main taxes are key to understanding mining sector taxation Indicative values (not to scale) Gross revenue TCRC Transport 1 2 Project economic waterfall (100% equity basis) Government take Costs Base for taxes 3 VAT reimbursable after 2018 Opex - Dep. 4 5 + Dep. - ΔNWC - Capex 6 Net revenue Extraordinary Income Tax Royalty Taxable income Profit Sharing Income tax Cash flow before SA Sovereign Adjustment Free cash flow Extraordinary Income Tax and Sovereign adjustment: Unlikely to be paid under normal circumstances, and never before discounted payback of the initial investment 3
Yr 1 Yr 2 Yr 3 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 US$ B ECUADORIAN TAXES OVERVIEW 1 Extraordinary income tax (EIT): revised in 2014 to apply only under limited conditions Extraordinary income tax only applies when two conditions are met 1 2 The company reaches discounted payback International price exceeds base price 1,0 0,5 0,0-0,5-1,0-1,5-2,0-2,5-3,0-3,5 Present value of historic cash flow EIT applicable if condition #2 is also met The base price is set monthly using the following formula: Base price = 10 year avg. real* price + 1 standard deviation Gold ($/oz) Copper ($/lb) Average X $1222 $ 3.39 σ There is a 17% that the international price of gold or copper exceeds the base price X + σ $1548 $ 4.10 17% EIT = 70% x units produced x (net unit sales price base unit price) * Ecuadorian law specifies that nominal prices will be converted to real terms using US CPI Extraordinary income tax formula 4
ECUADORIAN TAXES OVERVIEW The discount rate used for present value calculations is standardized in law, based on the Capital Asset Pricing Model The applicable rate for the extraordinary income tax and the sovereign adjustment is as follows: (1 + Nominal discount rate) 1 + Applicable Rate = (1 + Rate of inflation *) The nominal discount rate will be calculated using the following WACC formula: WACC = k E E + (k D D)(1 T)(1 U) (E + D) Where: k E = Cost of project capital k D = Weighted cost of debt of the project, which may not exceed the maximum interest rate benchmark set by the Board of the Central Bank of Ecuador E = Equity value of the project in accordance with the audited financial statements of the company D = Value project debt in accordance with the audited financial statements of the company T = Income tax rate (22%) U = Profit sharing rate attributable to the state (Utilidades al estado) (12%) The cost of capital is calculated using the following CAPM formula: k E = r f + β r ms Where: k E = Cost of capital r f = Rate of long term Ecuadorian sovereign bonds (varies, currently ~8.5%) B 0 = Industry risk in comparison to the market (fixed in the tax code at 1.2 for predictability) R ms = Market risk premium (fixed in the tax code at 5.0% for predictability) * Ecuadorian law specifies that nominal prices will be converted to real terms using US CPI 5
ECUADORIAN TAXES OVERVIEW 2 Royalties: precedent large-scale projects will pay 5% of net revenue Royalty formula Comments Royalty = Royalty rates for metallic mines: Applicable rate Gross revenue TCRCs Transport EIT Mining scale Rate Large 5-8% * Medium 4% Small 3% TCRCs: EIT: Treatment and Refining Charges Extraordinary Income Tax, if applicable * Rate for both precedent large scale mining projects has been 5% Royalties are revenue-based Are deductible from taxable income for basis of all other taxes (excluding EIT) The government is required by law to invest a minimum of 60% of royalties in the areas of influence Note: For non-metallic mines, minimum royalty rate of 5% 6
2016 2018 2020 2022 2024 2026 2028 2030 2032 Project s IRR ECUADORIAN TAXES OVERVIEW 3 VAT: Tax of 12% will be refundable for mineral exports starting in 2018 1 VAT formula In 2018, VAT will be refundable for mineral exports» This will enable refund of VAT paid on CAPEX and OPEX Legal maximum periods per phase Impact on a project s IRR The refundable VAT may increase a project s IRR between 1 and 2 p.p. ~ 1.5 p.p. Initial exploration 4 years Advanced exploration 4 years Economic Evaluation 2-4 years Exploitation VAT refundable Broad governmental support for this reform, but will be phased in to ease the transition Not refundable Refundable VAT for CAPEX & OPEX Source: Wood Mackenzie 7
ECUADORIAN TAXES OVERVIEW 4 Profit Sharing (a tax to enable workers to share in company profits): 15% of taxable income Profit Sharing = Profit sharing formula Comments Rate: 15% of taxable income 15% Net revenue Royalties Operating costs VAT Depreciation Interest EIT, if applicable For natural resources sectors, the tax is divided between workers and the general public: Mining scale Worker s sharing State s share Total Deductible from base for Income Tax Medium 5% 10% 15% Large 3% 12% 15% 8
ECUADORIAN TAXES OVERVIEW 5 Income tax: accelerated depreciation and fiscal stability contracts are available Income tax formula Comments Income tax = Rate: 22% of taxable income Accelerated depreciation: 22% Net revenue Royalties Operating costs VAT Depreciation Interest Profit-sharing tax EIT, if applicable» Depreciation period between 5-10 years, based on the company s preference Fiscal stability contracts are offered without an additional premium» Term: 15 years, or the same term as the qualifying title (concession, contracts, permits, etc.)» Renewable: up to 15 years or for the same term as the qualifying title extension 9
Yr 1 Yr 2 Yr 3 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 US$ B ECUADORIAN TAXES OVERVIEW 6 Sovereign Adjustment (SA): New law takes into account companies cost of capital and risk Legal base for SA tax Ecuadorian constitution requires that the government receives at least 50% of benefits from non-renewable resource projects Sovereign adjustment applicability calculation Company benefit = PV of cumulative free cash flows 6 4 PV of historic company benefit PV of historic government benefit Government benefit = PV of cumulative Royalties VAT Profit sharing (state portion) Income tax EIT, if applicable any previous SA payments 2 0-2 -4 Comments Under the new formula, SA is only payable if / when the present value of cumulative company benefits exceeds present value of cumulative government benefits Due to capital-intensity of mining, SA will not apply until late in the mine life, if at all 10
Agenda Ecuadorian taxes overview Recent incentives and reforms Competitiveness of the Ecuadorian tax regime Questions 11
RECENT INCENTIVES AND REFORMS Eight incentives and reforms approved in 2014-2015 have had a significant impact on project economics Fiscal and financial reforms 1 2 Fiscal stability contracts Accelerated depreciation, investor choice of 5-10 years 6 VAT refunds starting in 2018 VAT will be refundable for mineral exportations Increases IRR of projects up to 1.5% Helps regulate small mining and reduce smuggling; improves image of sector 3 Use of NPV for Sovereign Adjustment formula, to include companies cost of capital 7 Foreign investment in small mining New opportunities for investors interested in Ecuador Some small miners have potential to operate at larger scale on currently owned and/or new concessions 4 5 Currency exportation tax (ISD) exemption for mining sector Standardized extraordinary gains tax 8 Limited applicability of capital gains tax Previously, all share transaction were taxed with no limit on share value With the new change, only share transactions for more than 20% of the company value will be taxed 12
Agenda Ecuadorian taxes overview Recent incentives and reforms Competitiveness of the Ecuadorian tax regime Questions 13
Fiscal burden COMPETITIVENESS OF THE ECUADORIAN TAX REGIME Ecuador s tax burden is competitive compared with regional countries Fiscal comparison Government take as % of base 55 50 45 40 35 30 25 20 15 10 5 0 Method Large-scale copper project 54% Ecuador Regional Range 26% 19% Based on revenue 24% 34% 25% Based on operational revenue 1 1 Operational profit considered as Revenue less C1 costs 2 Free cash flow Source: Wood Mackenzie 32% 39% Based on Gov. Take + FCF 2 51% Assumptions and considerations Regional average includes:» Ecuador» Mexico» Colombia» Brazil» Chile» Peru Calculation assumptions:» NPV basis over the life of the mine, including construction» Same project economics in each method, but different denominators used Fiscal burden varies depending on project due to different costs structure In all projects, under all metrics, Ecuador is just slightly above average and within the regional range 14
Fiscal burden Fiscal burden COMPETITIVENESS OF THE ECUADORIAN TAX REGIME Projects with other cost structures yield different percentages, but do not alter the conclusion that Ecuador s tax burden is in the competitive range Fiscal comparison Government take as % of base Fiscal comparison Government take as % of base 55 50 45 Large-scale copper project 54% Ecuador Regional Range 51% 55 50 45 Medium-scale gold project Ecuador Regional Range 50% 40 35 34% 39% 40 35 34% 43% 30 25 20 15 10 5 26% 19% 24% 25% 32% vs. 30 25 20 15 10 5 25% 13% 21% 18% 29% 26% 0 Method Based on revenue Based on operational revenue 1 Based on Gov. Take + FCF 2 0 Method Based on revenue Based on operational revenue 1 Based on Gov. Take + FCF 2 1 Operational profit considered as Revenue less C1 costs 2 Free cash flow Source: Wood Mackenzie 15
Agenda Ecuadorian taxes overview Recent incentives and reforms Competitiveness of the Ecuadorian tax regime Questions 16
Disclaimer Strictly Private & Confidential This report has been prepared for the Ministry of Mining of Ecuador by Wood Mackenzie Inc. The report is intended solely for the benefit of the Ministry of Mining of Ecuador and its contents and conclusions are confidential and may not be disclosed to any other persons or companies without Wood Mackenzie s prior written permission. The information upon which this report is based has either been supplied to us by the Ministry of Mining of Ecuador or comes from our own experience, knowledge and databases. The opinions expressed in this report are those of Wood Mackenzie. They have been arrived at following careful consideration and enquiry but we do not guarantee their fairness, completeness or accuracy. The opinions, as of this date, are subject to change. We do not accept any liability for your reliance upon them. 17
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