An investigation into the contradictory nature of the mineral royalty
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Date
2017
Authors
Kemp, Ruan Gerald
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Abstract
The purpose of this study was to mathematically analyse the South African mineral royalty formulae for an objective factual understanding of the intents and effects of the royalty,
against which official and academic perceptions of its intents and effects are juxtaposed.The core principles of the royalty are that it should not be a tax on beneficiation,
and that the royalty rate should be floating so that both a minimum rate and a variable rate on gross sales applies.
The minimum rate of 0.5 percent of Gross Sales ensures that the state always receive compensation for the ‘permanent loss’ of non-renewable resources.
The variable rate on Gross Sales is a function of the formula and provides for additional compensation from profitable mines, with the intent that profitable mines should pay higher rates.
In order to avoid penalising refined mineral producers for adding value, the parameters in the formula is adjusted, so that there are differential rates for refiners and miners.
A comprehensive literature review has revealed that these core principles have not been sufficiently questioned, and a further two conjectures was also identified,
namely that the variable royalty rates collect ‘rent’, and that, because it is a cost, the royalty will impact on cut-off grade.
In order to test these conjectures the royalty rates were restated as royalty payable; R, and it was shown that the royalty is in fact two separate flat rates.
It was further illustrated that the device which makes the royalty rates float is the profitability ratio , which is the quotient of earnings before interest and tax EBIT over gross sales,
as per the mineral royalty formulae. This device is borrowed from the gold tax formula, where, in
combination with a depletion allowance, it had the effect of providing equitable relief for marginal mines – in direct contradiction to the royalty.
Applying the method to test the conjecture that the royalty collects rent it was shown that the royalty impedes the formation of economic rent and collects a rent on land instead, with the flat
charge on gross sales compensating the state for the depletion of non-renewable resources, and the flat charge on EBIT payable to the state for the permission to mine.
In the application of the method to test the impact of the royalty on cut-off grade it was shown that only the minimum charge has an impact, with a seemingly insignificant factor impact of 1.005.
That only the minimum charge should be considered as cost for cut-off grade estimations, may be of significant import to the mine planner.
The charge on EBIT would however have an impact if the operation is highly geared, as the royalty does not allow interest deductions.
It was illustrated that the royalty effectively raises the interest rate on loans by a factor of 1.087 for refined minerals, and 1.125 for unrefined minerals.
In testing the conjecture that the royalty penalises mining and incentivises refining it was confirmed that the minimum charge on gross sales is necessarily a tax on beneficiation.
For all price differentials that are equal to, or lower than 72 percent, refining will attract a higher royalty, and the royalty can be regarded as a tax on beneficiation. For price differentials that
are higher, there are a certain minimum profitability required, given by X, where after the beneficiation effort is acknowledged.
Further research is suggested to investigate actual price differentials between different stages of processing for different commodities.
Other research suggestions are provided at the end of this report, as well as recommendations to National Treasury.
Description
A research report submitted to the Faculty of Engineering and the Built Environment, University of the Witwatersrand, Johannesburg, in partial fulfillment of the requirements for the degree of Master of Science in Mining Engineering (Mineral Economics).
May, 2017
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Citation
Kemp, Ruan Gerard (2017) An investigation into the contradictory nature of the mineral royalty, University of the Witwatersrand, Johannesburg, https://hdl.handle.net/10539/26032