COMPARATIVE ANALYSIS OF MINERAL POLICIES AND TAXATION SYSTEMS OF BOTSWANA AND SOUTH AFRICA Pule Phillip Makatane (Person Number: 1817127) A research report submitted to the Faculty of Engineering and the Built Environment, University of the Witwatersrand, in fulfilment of the requirements for the degree of Masters in Engineering. Johannesburg, 2021 1 Declaration I declare that this report is my own, unaided work. I have read the University Policy on Plagiarism and hereby confirm that no plagiarism exists in this report. I also confirm that there is no copying nor is there any copyright infringement. I willingly submit to any investigation in this regard by the School of Mining Engineering and I undertake to abide by the decision of any such investigation. _______________________________ October 12th,2021 Signature of Candidate Date 2 ABSTRACT Mineral taxation instruments continue to be a hot topic of debate for most resource rich countries including South Africa and Botswana. The local populations are of the viewpoint that not enough revenue is generated from mining companies for economic growth and development whilst mining companies’ primary objectives are to enhance shareholder value through generation of profits. The study focuses on three main parameters of mineral taxation instruments, namely mineral resource rents, mineral income tax and mineral royalties within both Botswana and South Africa. Botswana’s and South Africa’s mineral income tax, resource rents and mineral royalties are implemented differently but with the same overarching objective of attracting investments and maximising revenue returns. Further, while the mineral policies of the two countries are similar in terms of the objectives, the pathways or implementation modalities are different contributing to the different results that have been realised. Botswana and South Africa therefore must strike a delicate balance between their efforts to attract investments and maximise returns from mineral taxation systems. Botswana and South Africa adopt varying mineral taxation systems as they seek to address their mineral policy objectives. A historic trend analysis of taxation regime data on royalty rates, corporate income tax rates as well as their associated mineral resource rent rates was conducted as directed by the availability of data. In addition, a desk-top review of the mineral taxation policies of Botswana and South Africa, and statutory laws that may facilitate or hinder the implementation of the respective countries’ mineral taxation policies was conducted. South Africa adopts sliding scale formulas for the gold tax and mineral royalties whilst Botswana adopts a sliding scale formula only on the mining income tax. Both Botswana and South Africa apply differential corporate income tax to selected minerals, where in this instance Botswana applies differential taxation for diamond mining operations given the strategic nature of the commodity to the country whilst South Africa’s ‘gold tax’ has been introduced to facilitate continued operations for marginal gold mining operations. South Africa implements a mineral income tax at a fixed income rate 3 of 28% save for gold mining operations whilst Botswana implements mineral income tax on a sliding scale or a variable income tax rate. Each country aligns its mineral policies to the needs of its citizenry and therefore country comparison is always going to present challenges of misalignment of country objectives. The quantitative analysis outcome however revealed the effectiveness of each country's mineral taxation system, therefore enabling comparison between Botswana and South Africa. The mineral royalty taxes are lower in South Africa with a minimum of 0.5% for both refined and unrefined minerals. The mineral royalty regime for Botswana does not have the option of refined royalty rates which are subsidies meant to encourage beneficiation down the mine value chain. Botswana’s royalty rates are fixed percentages set at 10% for diamonds, 5% for precious metals and 3% for base metals. The corporate income tax is lower in Botswana with a minimum rate of 22% depending on profitability as it is applied on a sliding scale formula. In periods of “windfalls “and high profitability, Botswana’s income tax goes up to a maximum of 55% whilst mineral income tax for South Africa is fixed at 28%. South Africa implements resource rents on mineral royalties and the gold tax. The gold tax formula is (Y = 45-225/X). The maximum tax rate derived from the gold tax formula is 42.75%. Botswana uses income tax formula: (tax rate = 70 -1500/X) as a form of resource rent for Botswana mineral taxation system. The formula is based on profitability rates of mining operations as denoted by the letter X on the formula, yielding maximum tax rate of 55 at 100% profitability rates and a minimum tax rate of 22%, whilst profitability rates below 21.4% is not liable to pay income. Botswana and South Africa have both seen economic growth and development as consequence of revenue generated from mineral development activities through their various mineral taxation instruments albeit at different degrees. Economic growth has not equally translated into socio-economic development as evidenced by the relatively high gini index in Botswana attesting to prevalent 4 inequalities. For South Africa, the mining charter attempts to address the inequities within the mining industry by specifically targeting historically disadvantaged groups. 5 Acknowledgements My sincere gratitude goes out to Professor Hudson Mtegha for his support and guidance amid the challenges presented by Covid-19 pandemic for both South Africa and Botswana. I am truly thankful for your patience. I also wish to acknowledge the support and encouragement provided by my wife from the commencement to completion of the research report. Only god knows it has not been easy, in the midst of the storms your love and support remained a pillar of my strength. Thank you! 6 Table of Contents Declaration 2 Abstract 3 Acknowledgements 5 1.0 INTRODUCTION 9 1.1 Background 9 1.1.1 Resource rent tax 13 1.1.2 Mineral royalties 14 1.1.3 Corporate Income Tax 15 1.2 Africa context 16 1.3 Regional context: Southern Africa Development Community (SADC) 18 1.4 Overview of Botswana and South Africa mineral taxation history 20 1.5 Purpose of the Study 24 1.5.1 Research questions and study objectives 24 1.5.2 Scope of the study 25 1.5.3 Limitations of the study 25 1.6 Outline of the report 26 2.0 MINERAL TAXATION THEORETICAL AND EMPIRICAL CONCEPTS 28 2.1 Resource rent design and tax administration 32 2.2 Transfer pricing and tax avoidance 33 3.0 BOTSWANA’S MINERAL DEVELOPMENT 37 3.1 Botswana’s economy 39 3.2 Analysis of Botswana’s mineral policy 44 3.3 Mineral taxes for Botswana and their impact on national taxation regimes 46 4.0 SOUTH AFRICA’S MINERAL DEVELOPMENT 49 4.1 South Africa’s economy 51 4.2 Analysis of South Africa’s mineral Policy 55 4.3 Mineral taxes of South Africa and their impact on national taxation regimes 59 7 5.0 METHODOLOGY AND FINDINGS 61 5.1 Findings 62 5.1.1 Income tax of Botswana and South Africa 62 5.1.2 Mineral Royalties of Botswana and South Africa 63 5.1.3 Resource rents of Botswana and South Africa 64 5.1.4 Mineral sector contribution to Botswana’s GDP 66 5.1.5 Mineral sector contribution to South Africa’s GDP 67 6.0 DISCUSSION 69 6.1 Similarities in mineral policy and taxation systems of Botswana and South Africa 69 6.2 Differences in mineral policies and taxation systems of Botswana and South Africa 71 6.3 Implications of the different tax regimens for Botswana and South Africa 73 6.4 The learnings of Botswana’s mineral development 75 7.0 CONCLUSION AND RECOMMENDATIONS 76 7.1 Conclusion 76 7.2 Recommendations 78 8.0 REFERENCES 79 8 LIST OF FIGURES Figure 1: Gold tax sliding scale formula versus Botswana income tax 65 Figure 2: Botswana’s mining contribution to GDP over the years 67 Figure 3: South Africa’s mining contribution to GDP over the years 68 LIST OF TABLES Table 1: South Africa’s unrefined and refined royalty rates at various profitability ratios 64 Table 2: Mineral taxation regime of South Africa and Botswana 66 Table 3: Summary of similarities in mineral policy and taxation systems of South Africa and Botswana 70 Table 4: Summary of differences in mineral policy and taxation systems of South Africa and Botswana 73 9 1.0 INTRODUCTION 1.1 Background Mineral taxation is defined as any tax imposed on mineral resources by governments with the ultimate goal of attaining greatest benefit for the public whilst also encouraging investors into the mining industry of the country. Mineral taxation includes any tax levied on mineral resources to generate revenue for the country and this can be implemented in various modalities where each modality has associated benefits and unintended consequences. For several decades, developing countries have been trying to remain competitive in the development of their mineral resources (Balde, 2020). These countries count on their mineral exploitation projects to mobilise more essential revenue for their economic development. In an effort to remain competitive in attracting foreign direct investment most sub Saharan African countries were in a fiscal race to the bottom from around 1992 where increasingly lenient fiscal regimes were observed as a strategy to stimulate the mineral sector (Balde, 2020). In some countries, as a result of revision of fiscal regimes to attract investments, the mineral resource industry became favourable as compared to other sectors of the economy within these countries (Boadway and Flatters, 1993). The competitiveness of a fiscal regime is pivotal in attracting investment alongside geological risk, political and macro –economic risk. Governments have a difficult task in striking a balance for equitable share between investors and host nations as well as remain competitive in attracting investment (Shimutwikeni, 2011). Mineral taxation has been used by countries endowed with mineral resources to achieve various objectives, chief among them to attain maximum benefit for the nation whilst also facilitating direct investment into the mining industry. Mineral taxation systems are varied as dependent on the objective of the host country, of critical importance are special taxation regimes namely standard income tax, royalties and resource rents. Mineral taxation is a complex suite of levies that requires administrative skills to solve its various properties for optimal/fair sharing of resource rents. The various mineral taxation properties make it very difficult to assess its impact 10 on sharing of mineral rents (Daniel. et al 2010). Contract negotiations between governments and multinational investing companies require skills in mineral taxation and mining regulations. Most governments lack the capacity to administer complex suites of mineral taxation instruments as a result of inadequate skilled personnel, whilst the multinational companies have abundant skills in all the relevant professions to recoup revenues for their investments. Cumulatively, these factors may undermine the efforts of mineral endowed countries to harness maximised revenues from mineral taxation and by extension limit the extent to which such countries realise their intended objectives through mineral taxation. The mineral resource industry has been the backbone of most developing nation’s economies over the years notwithstanding the limitations associated with the wasting nature of the non-renewal mineral resources (Shimutwikeni, 2011). Therefore, investors seek to make returns on their capital investment as early as possible to manage the risk of diminishing returns through an early payback period. Mineral rich developing countries are keen on creation of long term employment, stimulation of the host country’s economy through economic diversification activities as boosted by revenue derived from mining. It is against this background that developing countries impose varied types of taxes on their mineral resource exploitation activities to maximise their revenues. Paredes and Rivera, (2017) assert that fiscal regimes in the mineral exploitation industry enable revenue raising tasks of resource dependent economies to protect citizens against economic shocks. Further, local governments may reduce their efforts in collecting other taxes with higher political costs. This is especially true for Botswana with the lowest standard income tax at 25% maximum for her residents. Residents of Botswana are still afforded free education and medical assistance with diamonds projected to deplete shortly after 2030. Perhaps it’s the right time for Botswana to engage in a radical economic diversification drive. The complexity of mineral taxation regimes is compounded by the competing interests of both the host country and the investing companies where investing companies require the existence of adequate profits and sufficient compensatory returns. For example, the government should 11 ensure security of tenure is provided to allow for security of investment for a specified period. Therefore, an optimal and fair mineral taxation regime with an equitable share of profits for all stakeholders is desired. The intention is to reflect both the needs and aspirations of host governments, mining investors and local communities, while at the same time addressing how available mining skill sets and knowledge can best be integrated in practice. Local capital development including human development remains a very critical aspect in mineral development drive for resource rich countries as it reduces training costs for investing companies. Additionally, economic, social, political, and social status of mineral-rich countries are varied with optimal taxation subject to each jurisdiction, a factor which adds to the complexity of deciding and administering tax regimen. Besada (2016), states that policy debates on the continent are centred increasingly on how best to manage the exploitation of natural resources so that they produce benefits for all concerned. Although it is of paramount importance for countries to have a competitive mineral taxation regime to attract investment into the country, factors including geological endowment of the country, political stability and capital availability (skilled human capital and other project resources) are also critical in attracting investment. These factors may play a significant role in deriving a state mineral taxation regime. A combination of all these factors contributes to the uniqueness of each country with varied prioritization of areas of interest. Tilton (1992) contended that ultimately competitiveness must be on natural economic forces that present low operation costs for mining firms and that public policy may enhance the competitiveness of mining firms through incentives geared towards an enabling achievement of lower production costs. These costs are therefore dependent on the strategic intent of an individual state through regulations and mineral policy. The mineral sector is unique and therefore resource-rich countries must take full advantage of the comparative advantage of mineral occurrence within their jurisdictions for economic growth and development as well as economic diversification. The World Trade Organisation (2010) asserts that comparative advantage in minerals will result in production and export of minerals along 12 with the production of non-traded goods for domestic consumption, and the import of all other goods that can be traded. Tilton (2018), asserts that the future threat of mineral depletion is often difficult to predict as a consequence of unreliable forecasting of technological changes needed to offset the cost increasing effect of depletion. Governments must generate revenue while minerals are still available, through imposing levies on income, capital gains or estate taxes for utilisation in the provision of public service and economic development. Special mineral taxes are levies that augment with increasing returns and allow the government to recoup differential rents for good grades and windfall profits. While special tax regimes are the widely used tax instruments for capturing of production ‘windfalls’, for some countries implementation of this instrument remains a challenge as often additional procedures and management and administrative skills are required which may not be readily available. Mineral taxation instruments include corporate income tax, royalties, resource rent tax and capital redemption. Banda & Kabwe (2019) state that resource rich countries sometimes fail to extract maximum benefits from mineral taxation as a consequence of poorly designed taxation regimes. Therefore, governments need to put much effort in designing robust fiscal instruments that provide the opportunity to equally recoup financial benefits as with mining companies. On the contrary mining companies are cognizant of the risk of investing in the mineral exploitation industry with upfront massive capital investment, long production periods and long payback periods. It is therefore in the interest of the mining company to favour/opt for mineral taxation systems that allow for high returns in investments. Countries with regressive mineral taxation systems tend to lose out in maximization of returns in times of commodity price booms. It is therefore imperative that governments derive strategies from which opportunities are not lost as a consequence of regressive tax systems. Other governments introduced resource rent tax instruments to maximize returns during periods of commodity price booms. Resource rent tax instruments are rarely implemented on their own but are rather built into the corporate income tax or royalty tax. While special tax regimes are the widely used tax instruments for capturing of production ‘windfalls’, for some countries implementation of these instruments remains a challenge as often additional procedures and 13 management and administrative skills are required which may not be readily available (Commonwealth Secretariat, 2009). The commodity prices are also very volatile translating to inconsistencies and unreliability of revenue generation from mineral exploitation activities. These prices are a consequence of commodity supply and demand in the marketplace. Mining companies do not set the price for their commodities but are instead price takers as determined by the markets. Most metal price history exhibits swings resulting in operational losses and profits over the years. Mineral taxation regime must be cognizant of commodity price volatility and be able to maximize returns in windfall periods. Good governance is required for prudent management of mineral resources to benefit the country as a whole and not to fall into a resource curse trap. The resource curse is defined as the failure of many resource-rich countries to benefit fully from their natural resource wealth, and for governments in these countries to respond effectively to public welfare needs (Farooki & Kaplinsky, 2014). Mineral exploitation returns derived from mineral taxation systems are greatly impacted by the level of checks and balances intended to apply effective institutional safeguards against their use for political mileage. Good democracies tend to provide robust pressures to resource rent-seeking attitudes through the provision of quality institutional oversight bodies mandated to ensure country-specific objectives are realised. Samis (2007), states that variability of minerals and energy prices has assisted governments justifying incorporation of windfall profits tax into their mineral taxation instruments. Mining companies must also be able to calculate the impact of windfall taxes on the economics of the project. All the risk to the project cash flow must be exposed for both the country and the investing company to be incorporated in determining the project economic viability. Samis (2007) reiterates the use of advanced mineral valuation techniques to inform both governments and mining companies on the impact of windfall taxes and royalty taxes. 14 1.1.1 Resource rent tax Resource rent is defined as the excess of revenue from costs of production, including those of discovery and development as well as normal return on capital (International Monetary Fund, 2012). It is therefore important for resource rich countries to understand critical elements within resource rents to determine an optimal and economical neutral tax. “The key to an effective fiscal regime is to direct taxes at profits and not revenue” (Shimutwikeni, 2011). Laporte and Quatrebarbes (2015) explain rent in agricultural terms as dependent on the difference in fertility between pieces of land and thus correspond to the difference between marginal costs and commodity price. Cloete and van Rensburg (1984) assert that resource rent taxes are neutral and therefore should not influence the allocation of resources. They further explain that a portion of the earnings from production is not rent but rather the return necessary to attract or retain investment in mineral exploitation activities. Resource rent tax is mostly determined according to the application of a formula and becomes positive only after a specific profit is attained. At this threshold higher profitability leads to higher taxation rates. Governments need to have knowledge of commodity price, operational costs as well as discount rate. It is critical to understand all cost drivers and revenue generation parameters since profitability is a function of the difference between total revenue generated and total costs. Although it is not easy to acquire all the necessary information for governments to maximize returns, relevant data must be available to inform resource rent rates. Resource rent sharing between governments and investors is a very sensitive and delicate act between the desire to attract international investors for mineral exploitation and for sufficient capturing of rents by governments. A study on resource rents performed by Cloete & van Rensburg (1984) revealed that as a variant of resource rent tax, the gold tax has some advantages which are beneficial to both the state and the mining firm. The risk associated with investing in mining projects is covered and the mineral resource base of the country is fully utilised by the mining of low grade ores resulting in substantially extending the existence of mining operations. However, this taxation instrument can also lead to suboptimal wealth creation for the country if the taxation threshold is not activated as 15 a consequence of misallocation of resources. The application of resource rent tax must be aligned to safeguard the interest of the country. 1.1.2 Mineral royalties Mineral royalties are defined as payment to the holder of mineral rights for the utilisation of the mineral resource (Clinton, 2016). Royalties can be levied as a per-unit tax (fixed charge levied on a unit of production) or ad valorem which are fixed charges levied on value of output, or on gross revenues (World Bank, 2019). The mineral resource royalties are paid even when operations are making losses. It is important that both the government and the mining company on either side of the equation are equitably satisfied. Lilford (2017) asserts that both company and country are rarely satisfied by the application of mining royalty taxation instruments due to conflicting objectives where the government seeks to maximise returns for the benefit of the greater population whilst the mining company’s objective is to increase shareholder value through increased profitability. Clinton (2016) performed a study on seven Witwatersrand gold mines to consider the impact of mineral royalties and the benefit realised by the state. The study accessed the current tax and how it affected mining operations as well as investment decisions. The study used both the profit optimized and Net Present Value (NPV) optimized model. The study revealed that if royalties were levied only on profits then it could not be considered for cut-off grade purposes as is the case with income tax. Mineral resource royalty is considered as a cost and is considered when determining the cut-off grades. Mining companies are in the business of mining to create shareholder wealth and therefore will only invest their capital in areas with profitable mineral grades. The study revealed the effect of cost increment as it relates to mineral reserve reduction to attain profitable status. Further, Clinton (2016) confirmed that an increase in cut-off grade due to an increase in costs leads to a reduction of available mineral reserves above the calculated cut-off grade. It also emerged that excluding the mineral resource royalty results in less revenue to the state only if direct taxes are considered as taxation instruments. Although the revenue for 16 the state is lower without royalties as a cost to the mining company, it may be eliminated or reduced to enhance value through unlocking of marginal grade mineral resources and consequently the extension of life of mine. Each of the mines considered for the study were impacted by the mineral resource royalty in a different way, due to variation in grade distribution. Royalties are paid on total mineral sale revenue, it is considered an additional cost that causes the cut-off grade to increase thus reducing life of mine and the benefits of employment and continued generation of income tax for the government. 1.1.3 Corporate Income Tax Corporate income tax is a form of taxation which is applied across the broad spectrum of all industries within the country. Corporate tax is charged on profits of a company’s accounting period and is payable after the expiration of that period (Merrills and Fisher, 2013). The income from corporate capital is taxed both at the corporate level and individual level. These tax instruments are determined by the country of operation and therefore will vary across jurisdictions depending on the objectives of the country. Companies are expected to perform self-assessment and must return their profits after determining the amount of tax due to the state. Most corporate income taxes are usually progressive, that is average tax rates increase with increasing income (Hines, 2001). This translates to higher rates of taxes for large corporate companies with higher income. It is therefore of paramount importance that governments dedicate a lot of time on planning activities and corporate tax obligations of big mining companies since income is concentrated in a relatively small number of big mining companies. Corporate income tax is the major source of revenue for governments across all sectors of the economy. 1.2 Africa context Local entrepreneurs and Governments lack the capacity to mine mineral resources themselves and therefore have to attract foreign direct investment and capture a fair share of mineral resource rent. The commodity price boom between 2002 and 2008 multiplied the total world 17 resource rent by 2.3%, whilst tax revenue earned by African governments only grew by a factor of 1.5% (Laporte and de Quatrebarbes, 2015). The sharing of mineral taxation revenue and resource rents between African countries and investors have often been referred to as unfavourable for African governments. Capacity building of local human resources and capital development within the African continent is of paramount importance to meaningfully engage through the mineral development process within the region. Efforts to improve governance within the African continent emanated from the collective development of the African Mining Vision (AMV) which is a continental policy with the intent to align individual African countries with the continental policy. The AMV is a policy framework that is intended to assist Africa to utilise its mineral resources strategically for broad-based and inclusive development (United Nations Economic Commission For Africa, 2009). The AMV charts a path for creating and realizing various linkages arising from mineral exploitation through mineral development and technical upgrading. Since gaining independence most African countries were not fully integrating mineral exploitation activities into their economies. This includes lack of meaningful strategies for deliberate economic growth and development as well as infrastructure development. The AMV seeks to promote the alignment of national mineral policies, enhance policy coherence and stability in mining sector regulation, a key factor for transparency, competitiveness and promoting mining investments. Further, the AMV stipulates that companies working in the African mineral sector respect tax avoidance and evasion guidelines by ensuring they pay the right amount of tax in their host countries. Maximisation of revenue from mineral exploitation activities depends on the strength of mineral taxation systems of host countries as well as adopting good management practices. It also takes into consideration the mineral endowment opportunities within African nations, critical factors of consideration being the use of resource differential and windfall rents to improve the physical and knowledge infrastructure, downstream value addition, upstream value addition and technological advancements. Further, these activities through taxation of numerous sectors 18 linked to mineral exploitation activities are intended to generate additional revenue to the government as well as create employment for African countries. According to Maponga & Musa (2020) the AMV, adopted by African Union Heads of State and Government in February 2009 as the continental blueprint for mining-related development, identifies local content as one of the strategies towards a stronger and more domestically orientated sector and the creation of opportunities for local stakeholders along the mine value chain (MVC). Africa is the world top producer of several minerals and has the world greatest mineral resources of many more minerals (UNECA 2009). Africa’s mineral endowment is a comparative advantage to enhance economic growth and development strategy for Africa. These minerals are produced and exported as raw materials without significant value addition to developed countries. The potential for beneficiation and linkages to promote Africa’s need to industrialise still exist. These mineral exploitation activities must therefore benefit the African community by revenue generation through implementation of robust mineral beneficiation activities as well as adoption of competitive mineral taxation instruments to prevent mineral revenue leakages. Further, the AMV is particularly intentional in improving linkages between mining and the broader African economy and encourages individual member countries to promote local content and empowerment of citizens in policy and investing in human resource development especially in high technical skills required in the mining sector. Local content and local beneficiation are intended for increased levels of participation by locals to enhance developmental roles by mining and its contribution to economic transformation and industrialisation. Additionally, the AMV recognises the importance of artisanal small scale mining in terms of employment creation and revenue generation within communities for sustenance and local business development. This is consistent with the Abuja Treaty of 1991 that established the African Economic Community which called for coordination and harmonization of policies and programs across member states on areas of energy and natural resources including information exchange on prospecting, exploiting and using of natural resources including water (Salman, 2002). These included 19 harmonisation of policies on skills development to better position countries to fully harness the value of their mineral asserts Maponga and Musa (2020). Concurrently this will support the Lagos Plan of Action to promote Africa self-reliance through mineral resource development which seeks to promote skills transfer and development, economic data development between member states as well as infrastructure development. The policy directions on mineral exploitation, local content and beneficiation and linkages provided by the AMV are captured on various regional and national policies, legal and regulatory frameworks. The AMV direction resonates well with the Southern Africa Development Community (SADC) regional aspirations which seek cooperation and a level playing field to guide policy and transform the socio-economic landscape of the region. 1.3 Regional context: Southern Africa Development Community (SADC) Southern Africa is home to the world's richest mineral deposits. South Africa alone is estimated to have non-energy minerals worth upwards of US$2.4 trillion, making it the wealthiest mining jurisdiction in the world, that is if petroleum reserves are excluded (World Bank, 2019). Although the region has the richest mineral deposit in the world, high levels of inequality are still very prevalent within SADC member states. Efforts to harness mineral development activities and leverage on comparative advantage within the SADC region are to be realised through the implementation of the SADC regional mining vision. The SADC regional mining vision is premised on the principles of the AMV and its objectives are to optimise sustainable development impact of mineral resource exploitation in the region, whilst also recognising the different stages of maturity of the mineral sector in the region (SADC, 2018). One of the critical aspirational elements of the vision is the realisation of mineral fiscal linkages in the SADC region, through optimal mineral taxation and other fiscal instruments, for tax collection and compliance and for the management of resource rents for equitable development, fiscal stabilisation and intergenerational equity. Although the SADC Regional Mining Vision is yet to be implemented in the region, its aspiration of optimal taxation and collection and equitable 20 sharing of the resource rents are of paramount importance in aligning the region to the best industry practices. The SADC aspirations are critical in enhancing value for sustainable development and economic growth through maximisation of revenue from mineral exploitation activities. Recent mineral policies reviews seek to respond to changes in political and economic circumstances for host countries to maximise returns for economic growth and development. According to Mtegha, Cawood and Minnitt (2006) if all SADC regional countries had mineral policies then the development of a regional policy would be designed through a harmonisation process entailing multi-disciplinary engagement with different stakeholders to address socio-economic, political and environmental issues with the view to improve the quality of life for the greater regional population. The benefits of harmonisation are creation of a large regional market, higher pool of technical skills and enhanced capacity to positively respond to sustainable development challenges. The SADC region protocol on mining provides the overall direction for the operation of the mineral sector with the main objective of fostering a sector capable of economic growth and development, contributing to poverty reduction and enhancing the overall standard of living within the region. The protocol significantly highlights collaboration within member states through harmonisation of national and regional policies, human resource development, private sector mineral exploitation and promotion of artisanal and small scale miners (ASM). Maponga and Musa (2020) assert that regionalization of local content is a critical strategy of the AMV and mineral sector policy harmonization as outlined in the SADC Protocol on Mining, along with its long term objectives of the SADC Industrialization Strategy and Roadmap (2015-2063), and it’s Action Plan and the SADC Revised Regional Indicative Strategic Development Plan (2015-2030). SADC member states are dependent on the use of both royalties and CIT as mineral taxation instruments through which they obtain their share of resource rents. These taxation instruments are however not adequate to maximise returns during periods of high profits, as a consequence some member states incorporated the resource rent taxes. SADC 21 (2018), indicates a number of countries within the region have introduced resource rent taxes or variants, examples of which are Zimbabwe, Mozambique and Malawi. South Africa and Zambia have mining tax variants based on return on sales. SADC (2018) highlights the effects of royalties in stimulating investments in new mines and mining more reserves from existing mines. The royalty taxes influence the cut-off grades and therefore is a major determinant in mineable reserves and consequently the life of mine. Higher royalties tend to sterilise potential ore reserves with the subsequent unfortunate decision to reduce life of mine. Marginal grade new mining projects are also made economically non-viable at higher royalty taxes. Member states of SADC produce two-thirds of Africa’s mineral exports by value (KPMG, 2013). Southern Africa is home to the world's richest mineral deposits. South Africa alone is estimated to have non-energy minerals worth upwards of US$2.4 trillion, making it the wealthiest mining jurisdiction in the world, that is if petroleum reserves are excluded (World Bank, 2019). Although the region has the richest mineral deposit in the world, high levels of inequality are still very prevalent within SADC member states. 1.4 Overview of Botswana and South Africa mineral taxation history Botswana and South Africa are two of Southern Africa’s mineral-rich economies. For many developing countries, it is often the government that owns the mineral resources and by extension the recipient of any revenue flows from the harnessing of these resources (World Bank, 2010). This concentration of revenues with the government as the conduit of benefits to the rest of the economy can lead to a host of problems, including rent-seeking, corruption, and the efficiency losses with consequences of economic retardation. The mismanagement of mineral exploitation revenues tends to slow down economic growth and development as a result of a lack of investment to grow the economic base. Taxation regimes across sectors of the economy are evaluated and assessed in accordance with standards under prevailing market conditions. Countries tend to adopt a single national taxation system across sectors of the economy under the pretext of administrative consistency and 22 political fairness. As Banda & Kabwe (2019) state, the mineral sector has several characteristics which makes its taxation very important for countries whilst also very difficult to administer. These attributes include high sunk costs, long production periods and long pay back periods which are a significant risk to the investing company. The mineral taxation system is unique/different to other sectors of the economy as a consequence of risk and uncertainties faced with the industry, relating to capital intensity and application of tax relief to recoup capital expenditure. As such mineral taxation, as opposed to other sectors of the economy, is levied for extraction of minerals from the ground. Royalties are levies imposed solely to compensate for the extraction of minerals and are not profit-based, while resource rents provide an opportunity for imposing higher mineral taxation than in other sectors of the economy. The existing comparative advantage of mineral resource endowment of both Botswana and South Africa requires stable political systems with good democratic ideals to dispense good oversight and robust corporate governance principles. Taxation regimens are derived from the existing mineral policies and legislation which are meant to serve the interest of both the host country and investing companies. Negotiations for determination of mineral tax rates between governments and mineral extraction companies have proven to be susceptible to bribery by extractive companies. Further, government delegates may have deficient knowledge about the true value of the mineral asset as compared to their extractive company counterparts. Cumulatively, these factors may result in lost opportunities for the host countries in realizing the objective of maximising returns from the mineral taxation system. Otto et. al., (2006) state that governments are rarely satisfied by the rates of mineral taxations and conversely mining companies never feel they pay too little tax, whilst the citizens never feel they get the full benefits of their mineral wealth. The selection of optimal mineral taxation is dependent on the tax evaluation methods which are derived from mining projects evaluation experts. Notwithstanding all the evaluation processes, the correct balance is determined by the economic context of the state and consequently the political aspirations of the state. Therefore, the selected taxation system might be optimal for one country and be sub-optimal for the next country depending on the prevailing 23 economic and political needs of the country. However, resource rich countries' strategy is to maximize returns from mineral exploitation and broaden the economic base through implementation of strategies meant to boost other sectors of the economy. South Africa’s modern mineral sector was established in the late 1800s with the discovery of gold and diamonds. Large scale mining started in the nineteenth century with a great focus on gold mining leading to rapid industrialisation accelerated by revenue generated from mineral exploitation. The agricultural sector was surpassed by the mineral sector as with other mineral-rich countries. Curtis (2009), asserts that mining was one of the industries at the forefront of the economy. Notwithstanding that, the gold resources are currently substantially depleted and with existing resources at great depth resulting in high operational costs for the mining companies. This has led to reduced gold contribution to the economy over the recent years as well as reduced employment within the sector which was once the mainstay of South Africa’s economy. The gold tax formula was introduced in 1936 upon the recommendations of the Corbett Commission (Cawood and Macfarlane, 2003) and is applied to gold deposits only whilst other minerals are incorporated in the standard corporate income tax. Nonetheless South Africa still has massive mineral resources, with coal and iron assuming very important positions in the economy of South Africa (IMF, 2015). The transformational process of substituting the old South African regime started soon after the 1994 national elections. The intent of the African National Congress’s radical mineral development transformational process was captured in the Freedom Charter of 1955 (University of Witwatersrand, 2013) which called for the mineral wealth of the country to be restored to the people of South Africa as a whole and opening up South Africa’s mineral resources for foreign investment. These processes played a key role in shaping the current South Africa’s mineral investment environment (Cawood, 2004) with subsequent mineral policy development leading to the introduction of the Broad-Based Socio-Economic Empowerment Charter for the Mining and Minerals Industry hereafter referred to as the Mining Charter, as a transformational effort by the government of South Africa. 24 These policies are designed to enhance economic growth within populations which were previously disadvantaged. It is an undisputed fact that the majority of South Africa’s black population remains disadvantaged with regard to enjoying the mineral endowment of their country. As a strategy to address this long-standing inequity, the mining charter proposes, amongst others, two regulatory instruments concerning ownership and shareholding as well as procurement of goods and services within the mining industry to achieve its objectives. These instruments are to enhance socio-economic status of mining communities and to advance employment and penetration into the mining industry by black population of South Africa. Revenues and economic activities generated from mineral exploitation, therefore, must be used to benefit all the citizens of South Africa through infrastructure development and economic growth. One of the objectives of the Mineral and Petroleum Resource Development Act (MPRDA) of 2002 is to allow people of South Africa to harness the benefits from the mineral resources of the country and to give ownership of resources to the country. Ainsley, (2013), asserts that the inability of countries to derive value out of their mineral wealth and generate income for infrastructure development and economic growth is pertinent and is seemingly in Africa’s largest economy. South Africa is not spared of the resource curse symptoms as it relates to slow GDP growth, entrenched poverty and high unemployment rates thus comparing favourably with Sub- Saharan countries as opposed to its upper middle income peers. Most of the middle and upper income jurisdictions have robust welfare, infrastructure and economic development trajectory for all. It is therefore of paramount importance for all resource rich countries to realise the full benefit from their mineral wealth for all of its citizens, including South Africa. It is therefore critical to analyse the mineral taxation systems of both Botswana and South Africa to identify the extent to which they harness their mineral wealth for the benefit of their citizenry. Similar to South Africa, Botswana has seen its best mining years in the recent past with significant economic contributions derived from diamond mining. Botswana's large-scale mining started in the 1970s with the introduction of diamonds, copper and nickel mines leading to the 25 domination of the sector as a major contributor to the gross domestic product (GDP) (World Bank, 2010). Diamonds significantly changed the trajectory of Botswana’s economy with major revenue contributions to enhance rapid economic growth and development. Although diamonds were major drivers of the economy, there was the subsequent discovery of other minerals albeit in small quantities, namely gold, coal and industrial minerals. The country has since realised a significant decline in diamond production with mines operating at depth coupled with loss of production as a consequence of depletion of the Letlhakane open pit diamond mine. Further, Botswana has a few base metal mines which are rather marginal in terms of profitability as evidenced by previous liquidations in almost all their mining operations consequent to recent commodity price decline. The mineral taxation instruments for both Botswana and South Africa include mining royalties, corporate income tax with varying degrees of mineral taxation instruments implemented to recoup profits during periods of windfalls. Botswana implements an income tax of a minimum of 22% having been amended from 25% in 2009, and a royalty tax that is resource-dependent. The South African corporate income tax is at 28% for all commodities except gold. The government of South Africa as custodian of mineral rights has a claim on mining revenue in three ways; a) royalties, b) corporate income tax and c) dividends tax. Cawood (2010), describes these as positions that are either first or middle on the hierarchy of claims on mining revenues which are held by governments. While both Botswana and South Africa are some of the mineral-rich countries in the African continent, the extent to which both countries harnessed their mineral wealth to benefit the current generation, as well as future generations is a subject of continual debate. Both countries have gone through a transitionary period where the main driver of economic growth was the mining sector. Due to the depletion of mineral resources with continual production, and predictably so, both countries have realised a diminishing contribution of mineral revenue to economic growth and development, albeit with South Africa’s decline occurring earlier. South Africa just like Botswana had its economy reliant on mining in her earliest years of mineral discovery. The mineral contribution to South Africa’s economy has 26 since declined with slow depletion of its mineral reserves. This is despite the institution of various taxation instruments in the country 1.5 Purpose of the Study The study focuses on three main parameters of mineral taxation instruments, namely mineral resource rents, mineral income tax and mineral royalties within both Botswana and South Africa. While the two countries are well endowed with minerals, they have implemented different taxation regimes on the mineral resources yielding different results for the nations. Further, while the mineral policies of the two countries are similar in terms of their objective in maximising returns and attracting investments, the pathways or implementation modalities are different contributing to the different results that have been realised. The objective of each country is to maximise returns through collection of mineral taxation revenue from mining operations, with a view to still remain attractive to investors. It is therefore critical for the purposes of this study to compare mineral taxation rates for both countries and identify possible areas of revenue leakages for possible future improvements on Botswana and South Africa mineral taxation systems. The study will analyse the ability of Botswana and South Africa's mineral taxation system to recoup profits during times of commodity price booms as well as their mineral contribution to each country’s GDP over the years. Therefore, the study summarily is a comparative analysis of mineral taxation systems of both Botswana and South Africa 1.5.1 Research questions and study objectives The primary study question is: a) From a mineral taxation perspective, to what extent did the mineral taxation suite of instruments implemented in Botswana facilitate the country realising the objectives of its mineral taxation policy compared to South Africa. The specific objectives of the research are: 27 a) Discuss theoretical and empirical aspects of mineral taxation; b) Identify any similarities and differences in implementation of mineral taxation modalities in Botswana and South Africa; c) Describe the benefits and limitations of various mineral taxation instruments as used within mineral taxation policies in Botswana and South Africa; and d) Analyse the influence/impact of mineral taxation systems on the national taxation regime across all sectors of the economy in both South Africa and Botswana. 1.5.2 Scope of the study The report will specifically focus on corporate income tax, resource rents and mineral royalties as components of the mineral taxation regime. This will entail the extent to which both countries are continually reviewing their mineral taxation policies to remain competitive and benefit both the current generation as well as the future generations. 1.5.3 Limitations of the study Mineral taxation information is not readily available for analysis and interpretation, therefore this report used mineral taxation information which is not classified as confidential. In the case of Botswana, diamonds are classified as strategic minerals for the country as it creates more monetary value to the country than other mineral commodities. Further, access to diamond taxation is confidential as it is an agreement negotiated between the investor and the country. The Covid -19 pandemic created an added challenge of restricted travel within zones in Botswana as well as across the border into South Africa to obtain relevant information for the report. Government and private sector employees were working from home for extended periods of time and therefore access to some information at their place of work presented some challenges. Data limitations are significant, restricting research conclusions on whether the benefits from mining for both countries are negative or positive. Additionally, there was some dispute over the 28 mining charter. In 2019, the Minerals Council South Africa (MCSA) filed an application to take the third mining charter on Judicial review (World bank, 2019). The council challenged a number of provisions in the charter with a special emphasis on the “Once empowered always empowered” principle. Although the mining charter is gazetted for implementation, assessment of compliance to all the elements of the charter is yet to be determined. Previous assessments have shown that mining operations were not compliant to the elements of the mining charter. Comparing two different countries with unique country objectives presented its own challenges since their mineral policies as well as mineral taxation systems will be set to satisfy country specific objectives. Although the broad mineral policy objectives are the same, the modes of implementation are variedly different. 1.6 Outline of the report The report is divided into two main sections where coarsely, the first section focuses on review of the existing knowledge base and evidence whilst the latter section focuses on methods and approaches as well as findings and recommendations from the current study. Chapter 1: The first chapter of the report provides a historical context of mining development in Botswana and South Africa and a consideration of economic diversification efforts in the two countries. The section also provides an overview of mineral taxation as a development exercise, and how the two countries have implemented mineral taxation over time using the various taxation instruments. Specifically, this section will focus on three mineral taxation instruments namely, income tax, mineral royalties and resource rents. The last part of the initial part of the report will provide descriptions of regional and continental mining frameworks including efforts for harmonisation with country level policies. A brief synopsis of both the regional and SADC policy strategy in development of mineral resource management capacity with specific interest in mineral taxation. 29 Chapter 2: This chapter highlights characteristics of the mining industry and how they influence mineral taxation systems. This chapter discusses the application of mineral taxation instruments as used in mineral taxation regimes. This chapter discusses critical elements of consideration in management of transfer pricing and resource rent management as these are critical elements in the government's effort to maximise returns from the resource sector. Chapter 3: The third chapter focuses on mineral development efforts of Botswana with special emphasis on the country’s mineral policy, Botswana’s economy, mineral taxes and minerals industry contribution to Botswana’s GDP. An analytical view of how the mineral industry supports and nurtures other industries as it is pivotal in realizing economic structural changes is undertaken. This is critical since mineral resources are a wasting asset and therefore long term dependence on the mineral industry may prove to be detrimental to the economy as mineral resources deplete. It has however been advanced that resource rich countries should prioritize developing industries with comparative advantages rather than to erode the economic base in a bid to diversify. Chapter 4: This section focuses on the mineral development efforts of South Africa, specifically on mineral policy development as outlined in the mining charter, mineral taxes and minerals industry contribution to South Africa’s GDP and the impact of mineral taxation systems on the national economy. The chapter also provides an analysis on the performance of the mineral industry contribution to South Africa’s GDP over the years. Chapter 5: This part of the report will focus on a detailed description of the methods and approaches employed to attempt to respond to the research question and a detailed description of the findings obtained. This part of the report will analyse mineral taxation instruments through a mixed method approach entailing quantitative and qualitative analyses to mineral taxation trends and policy objectives of each country. The mineral taxation instruments of interest are income tax, mineral royalties and resource rents. 30 Chapter 6: Focuses on the comparative analysis of mineral taxation systems and the mineral policies of Botswana and South Africa with special emphasis on similarities and differences between the mineral taxation policy of South Africa and Botswana. The chapter will also attempt to highlight implications of the different mineral tax regimes for Botswana and South Africa as well as the learnings from Botswana’s mineral development. Chapter 7: Summarises key findings of the report and highlights recommendations for future improvements as derived from the research question. The chapter will also provide conclusions on comparative analysis of mineral taxation systems of both Botswana and South Africa with special emphasis on similarities and differences. 2.0 MINERAL TAXATION THEORETICAL AND EMPIRICAL CONCEPTS Natural resources are a valuable asset for many countries and the management of revenue generated from these resources can have a significant impact on governments and nations, either positively or negatively (IMF, 2010). Therefore, in applying different taxation regimes, in principle governments are cognizant of the non-renewable nature of mineral resources and the criticality of the country exploiting the resources for accelerated economic growth and development. Mineral endowments have projected some countries into the path of sustained economic growth while for some countries corruption, maladministration, and persistent poverty, with little sustainable development to benefit future generations have been entrenched. (World Bank, 2020). In practice, the mineral resource sector is distinct with some characteristics that make its taxation distinctively unique but also particularly challenging. These features are not themselves unique to the resource sector alone but what is typical of them is their sheer scale and these include; a) high sunk costs; b) long lead periods to production; c) prospects of substantial rents and taxation revenue; d) uncertainty; e) market power; and f) international consideration and their exhaustibility (IMF, 2010). High sunk costs: Mining projects often require substantial upfront capital investment into exploration, developing and operational activities which may cost millions of dollars. The 31 associated expenses are incurred earlier at the initiation phase of the project, mostly at a time where the operation has no cash flow and as such are sunk into the project leaving few to no options for the money to be withdrawn and invested elsewhere. This high opportunity cost means that investors will require a certain level of consistency in the fiscal regime of the country including offering incentives such as optimal tax rates for the entirety of the mining project (IMF, 2010) and if it is too risky or difficult to predict, investors may choose not to invest. Once the investors have incurred these sunk costs they have limited options but to go ahead with the project. Failure by governments to assume an accommodative and optimal tax rate may result in the “hold up” phenomenon where investors are reluctant to invest due to future uncertainty in the taxation regime. This is often a country specific risk that is associated with stability of the political and tax systems (Mathivha, 2016) the latter assessed through an analysis of behavioural patterns of government in previous investments and during periods of“windfalls” and price busts. To remain competitive, some resource rich countries use capital redemption against qualifying capital investment expenditures such as shaft sinking and equipping the mine (Van Blerck, 1998). The applicable capital redemption which is off-set against tax liabilities during the early phases of operations varies between countries, with Botswana and South Africa offering 100% capital redemption. Further, some assets eligible for partial deduction of capital expenditure include residential facilities, vehicles and railway lines (DME, 1998). Mining projects require high capital investment for shaft sinking, developments, expansion and equipment replacement. Capital costs are recovered over the life of mine as deductions revenues as a form of tax shield known as capital redemption. The capital costs are redeemed in the early years of mining production therefore allowing mining investors to recover their capital expenditures. Long lead periods to production: Given the highly competitive nature of the mining industry and the numerous potential investment destinations for investors (World Bank, 2020), one of the features of the industry that makes taxation a complexity is the fact that investors are attracted to jurisdictions where the investors project the ability to operate profitable entities for a long period, and often this confidence is linked to the stability of the political and financial environment. This has resulted in some countries implementing a 100 percent capital redemption for investors to 32 recapture all their initial capital investment expenses on the project. In this scenario, governments can only apply tax to profits after capital costs are fully recovered. Uncertainty: At all stages of mineral resource projects from development to project closure, a considerable amount of uncertainty persists. Geology also possesses its own uncertainties in terms of resource quantification as well as resource quality. It is critically important for both the investor and the government to fully understand the nature of the mineral asset prior to making investment decisions and taxation designs. Geology is a fundamental aspect underpinning the determination of the project economic feasibility for investor decision making on whether to pursue or discard the project. Other forms of uncertainty are commodity price volatility, which is a distinctive characteristic of the resource sector. Large and rapid price changes are associated with uncertainty and variability in aggregate rents acquired over the life of the project. Commodity prices are subjected to long cyclical periods of either booms and busts with critical implications on the national economies (World Bank, 2020). This ultimately impacts strongly on public discourse on the tax treatment of the resource sector and ultimately impacts decision making processes pertaining to tax design and its effect on total rents. This is a considerable risk for the government in fiscal management as a consequence of the creation of the period's lack and abundance with the government to implement cushionary measures against economic shocks. International consideration and their exhaustibility: The technical and managerial competencies and skills required for developing and extracting natural resources are not readily available in countries endowed with minerals. Foreign-owned companies commonly undertake the development of resource projects in partnership with either government or privately owned companies. This is not unique to the sector but has several implications where more than one jurisdiction may seek to tax mining projects. Therefore, governments and investors concerned may benefit from assessing the combined impact of these taxes. This is premised on the fact that an effective tax rate is dependent upon the cumulative effect of taxation systems in the host 33 country, home countries of the investing entity, and countries of residence for the owners of the investing company. While standard corporate and withholding taxes are creditable to the home country, royalties are not. Therefore, an awareness of the interactions between different taxation systems may impact the design of mineral taxation (IMF, 2010). The CIT is a critical component of the fiscal regime of all countries. In designing a corporate tax regime, an awareness of current global trends by governments is important and this includes sensitivity to corporate tax competition and any changes to corporate tax regimen in other countries as such changes are often focused on attracting investment and may affect the revenue yield for the country. Mineral companies may be subjected to a higher tax rate within the standard corporate income tax regime, and in some instances this may be varied in accordance with taxable income. As these regimes are designed and implemented differently across resource rich countries, some countries design their mineral taxation systems based on negotiations between the government and investor rather than assuming a blanket taxation approach across all sectors. Corporate income tax is less distortionary as compared to royalties since they are profit based but are relatively more complex to administer (IMF, 2010). A steady decline of corporate income tax has been observed over the years across the globe suggestive of tax competition, with the average CIT rate in Organisation for Economic Cooperation and Development (OECD) countries decreasing from 36 percent in 1997 to 27.8 percent in 2007 (IMF, 2010). The European Union nations have recorded a significant decrease with the average rate sliding down from 35.5 percent to 24.2 percent. Most minerally endowed countries in Sub-Saharan Africa have seen a decline from 40 percent to 35.4 percent from 1980 to 2005 (IMF, 2010). This taxation transformation is aimed at attracting internationally mobile capital. Although the tax rates have been reduced in OECD the general corporate tax revenues as a proportion of the GDP has remained stagnant whilst in developing countries the reduction in tax rate resulted in loss of revenue. This suggests insufficient and or lack of broadening of the tax base in developing countries whilst the opposite is true for OECD countries. 34 Mining royalties are unique to the resource sector and have manifested themselves in a number of ways, based on either the profitability or quantity of the material being produced or its value (Commonwealth Secretariat, 2009). Royalty is used as an instrument for compensation in exchange for granting mining companies access to minerals and the right to develop the resource for its own benefit (Cawood, 2004). Royalties have advantages and disadvantages regarding economic efficiency and division of risk between the country and the company and have been classified as a cost as it imposes tax on each tonne of metal mined leading to inefficiencies in production decisions for mining companies. Mining royalties ensure continual payment of taxes from initial project production stage to project closure mostly without regard for profitability. Royalties can be applied in one of three ways; a) Unit based royalty: These are applied at a fixed and specific rate per tonne of production (IDMC, 2012). This approach is associated with stable and early revenue and is relatively easy to administer and audit. However, unit based royalties can be economically inefficient and very distortionary as they do not adjust to circumstances of increased profitability. Further, they are insensitive to operational costs and are regressive in nature. b) Ad valorem royalty: This type of royalty is based on the value of production thus making them responsive to fluctuating commodity prices and giving the tax some of the pro-cyclical features of a profit tax (Clausing and Durst, 2015). They can be applied on the realised value of sales making it easy to administer since it's based on the predetermined sales information (IMDC, 2012). This approach also makes it advantageous where audits, administrative costs and dispute resolutions are concerned. Ad valorem royalties can also be applied as the gross value of the mineral or metal contained in the mineral product sold. Their computation requires the multiplying of the total weight of the mineral by their grades to obtain contained metal and the value is then derived from using the commodity price for the day of the sale. This approach requires validation calculations which might present some challenges for auditing 35 purposes. Further, ad valorem royalties could give rise to some transfer pricing concerns with incorporation of external prices, although at a smaller scale than in corporate income tax with smaller price manipulation on the tax base (Clausing and Durst, 2015). c) Hybrid royalty tax: This is a combination of taxation instruments that incorporates at a minimum a unit based and ad valorem component to minimize the possibility that the government may not collect revenue in the years that a project does not realise profits (IDMC, 2012). This type of royalty ensures generation of a minimum revenue stream into government financial reserves and also ensures that the government is prepared to take some of the risk in marginal mining operations by allowing for minimum rates for less profitable operations. 2.1 Resource rent design and tax administration Both investors and governments will not deny the existence of mineral rents as derived from mineral exploitation activities (Cawood and Minnitt, 2002). The management of resource rents to determine both the size and nature of rents have proven to be a major mineral taxation administration challenge. As a taxation instrument, resource rent tax can be applied to profits and as a combination with other instruments to attain a balanced and predictable tax system (IMF, 2020). A well designed resource rent tax will not distort investment decisions as a consequence of its neutrality and efficiency over other taxation instruments (IMF, 2010). Recent experience in mineral commodity price boom and bust has revealed the extent to which resource tax systems respond weakly to changes in the economic environment. Nonetheless, a balanced tax system provides host governments with predictable revenue options through the existence of the mining operations and also generates additional revenues as determined by the profitability of mining operations. A combination of other fiscal instruments with resource rent tax provides an assurance of earlier and more predictable revenue streams as well as reducing administrative challenges. 36 There is a need for a more balanced and flexible way to uphold the interests of both the host country and investors in all economic circumstances. A resource rent tax creates opportunity for maximization of revenue whilst controlling for distortion unlike other taxes. It is likely that countries with no resource rents are losing out on revenue generation during periods of high profitability in the mineral sector. Notwithstanding that profit based taxes can pose greater administrative challenges than non-profit taxes. The weak administrative capacity and challenges in good governance common in resource rich countries compounds the complexity and the pressure upon their limited capacity. 2.2 Transfer pricing and tax avoidance Transfer price is the price of a transaction between two companies that are part of the same group of companies. For example a company based in one jurisdiction might sell equipment, machinery or mineral products to a subsidiary company based in another jurisdiction. The agreed price between the two companies is the transfer price. The challenge in monitoring and taxing this kind of transactions is that they do not take place in an open market (National Resource Governance Institute, 2016). Therefore, in executing its mandate of managing mineral resources including revenue generated thereof, it is critical for governments to formulate policies and procedures on management of mineral revenues. Over the years, governments were continually faced with challenges regarding protection of the revenue base in the face of aggressive tax planning. Multinational companies almost always are at the forefront of tax planning with a significant advantage in terms of access to operation profitability information as well as competent personnel to assist achieve the mandate of the company (IMF, 2010). Governments are likely to leak revenue meant to benefit its citizenry through abusive transfer pricing when prices are misstated in order to shift the apparent source of profits to the taxpayer or countries that provide the most advantageous tax outcome. Abusive transfer pricing is characterised by minimising income and maximising deductions in a high taxation jurisdiction. 37 Abusive transfer pricing is a phenomenon that is often used to assist mineral exploitation stakeholders to minimise tax burdens from jurisdictions with high taxation rates with a view of increasing operational profits. It is usually in the interest of the taxpayer to make higher profits in lower taxed jurisdictions and lower profits in higher taxed jurisdictions to reduce their overall tax bill. For governments, this is a source of revenue leakage that ought to be addressed through protective measures and effective implementation of legislation and strengthening of tax administration capacities. Often, it is resource rich African countries that are exposed to this aggressive tax planning and tax evasion facilitated by widespread use of offshore companies (Clausing and Durst, 2015). This is compounded by the high levels of intra company trade and business surrounding foreign investment activities, and limited capacity in human, financial and technical resources critical to secure tax compliance and the commercial market intelligence needed to access company tax liabilities (Clausing and Durst, 2015). The insufficiencies in administrative capacity identified within African countries contribute significantly to revenue losses within the resource sector. Moreover, the income and the resource rent tax are vulnerable to transfer price manipulations by taxpayers since they are profit based. According to Natural Resource Governance Institute (NRGI) 2016, transfer pricing becomes abusive only if the taxpayer distorts the price of a transaction to reduce their taxable income. This makes both taxation instruments difficult to administer as a consequence of tax avoidance and the complexity associated with collecting tax. 2.2 Evaluation of Mineral taxation regimes Mineral taxation systems are evaluated primarily based on the following criteria; a) neutrality, b) progressivity; c) investor and government risk; and d) administrative efficiency (Banda and Kabwe, 2019). These criteria, described below, are of major consideration in designing mineral taxation systems towards achieving the desired balance of a number of government fundamental objectives. 38 a) Neutrality: This is the ability of a taxation instrument to cause the least possible distortion to private economic decisions that would otherwise be made in the absence of tax (Daniel et al, 2008). A neutral tax does not change economically marginal decisions on project investment or trade that would have been undertaken in the absence of tax. A fundamental condition of neutrality is that the optimal size of the reserves incorporates all ore blocks with a grade equal to or greater than the cut-off and this optimized reserve is not affected by fluctuations in tax rate (IDMC, 2012). Non-neutral taxation systems result in either too much extraction of the mineral resource or not extracting enough of the resource with a focus on high grading leading to sterilisation of marginal mineral resources. b) Progressivity: A tax instrument is considered to be progressive where the instrument yields a rising present value of government revenue as the pre tax rate of return on a project increases. Simply put, a tax is progressive when such a tax increases automatically with increasing profitability. These types of taxes, which are also less burdensome in periods of low profitability mean that governments with progressive taxes also bear a fair share of the risk associated with mineral exploitation activities. On the contrary, a regressive tax instrument gives rise to a heavy burden on projects of low profitability (Daniel et al, 2008). Mineral taxation systems with the highest ad-valorem royalties and standard corporate income tax systems are likely to be the least progressive (IMF, 2010). A taxation system that responds flexibly to economic changes is considered to be stable and it is less likely to increase risk since it will recoup less or nothing in periods of low profitability. c) Investor and government risk: Mineral taxation systems are evaluated through calculations of the Net Present Value (NPV) before tax and after tax cash flows. These calculations are used to incorporate the investor’s assessment of risk as a cost input. The Discounted Cash flow (DCF) method is used to calculate the NPV and future cash flows of the project. The future cash flows are discounted using risk adjusted discount rates or the hurdle rate (Daniel et al, 2008). For governments, the main risk associated 39 with this approach is variation in NPV of the project resulting in variation of proportion of revenues over the life project. Fiscal management for resource dependent countries therefore creates cyclical periods of surplus and lack depending on the rate of profitability of the mining projects. Despite public ownership of mineral resources, private companies are exposed to the risk associated with early substantial capital investment required, long exploration and pre-production periods during which no revenue is generated. At this stage of the project, return on investment is less likely guaranteed with uncertainties in future commodity prices as well as technical, political and environmental circumstances. The risk associated with unstable fiscal regimes is that higher taxation rates may be levied on currently operating mines that are captive to jurisdictions in which their resources are located (IDMC, 2012). This may lead to discouragement in future exploration and development investment in the country and instead the mobile capital will be directed towards countries with stable fiscal regimes. Therefore it is necessary for the government to strike a balance between the need to impose heavy taxation burden against inflow for necessary exploration and development capital to secure the future of mineral development projects. d) Administrative efficiency: Resource rich countries set mineral taxation rate and royalty policies that represent acceptable compromise and reflect some level of capacity to administer them. Implementation of the more administratively complex profit based, resource rents and associated hybrid royalty taxes have been rare in the past. The profit or rent base is determined on a project by project basis and therefore different application of capital recovery rules, allocation of common expenses and cost overheads may make determination of normal profits ambiguous and hard to audit (IDMC, 2012). Most resource rich countries have good legislation and rules to govern their tax administration but serious challenges arise in enforcement and implementation. This is more pronounced in underfunded or in countries that cannot attract the necessary skilled personnel. According to IDMC (2012), the most effective and efficient way for weak institutions to increase government share of economic rent is to retain specific and 40 ad valorem royalties and implement selective increases in corporate income tax applicable to mining. Summary. Natural resources are a valuable asset for many countries and the management of revenue generated from these resources can have a significant impact on governments and nations, either positively or negatively (IMF, 2010). Therefore, in applying different taxation regimen, in principle governments are cognizant of the non-renewable nature of mineral resources and the criticality of the country exploiting the resources for accelerated economic growth and development. A number taxation instruments can be applied within the mineral resource sector and these include corporate income tax, royalties, and resource rents. Royalties can be applied as unit based, ad valorem or as a hybrid modality. However, taxation within this sector is particularly challenging given the distinct characteristics associated with the sector and the scale of these features which include high sunk costs, long lag in production periods, uncertainty, market power to mention a few. Different tax regimens create different and distinct tax profiles and in evaluating these regimens some of the factors to consider include neutrality, progressivity, investor and government risk, and administrative efficiency. 3.0 BOTSWANA’S MINERAL DEVELOPMENT Botswana is located at the centre of Southern Africa, landlocked by South Africa, Namibia, Zimbabwe and Zambia. Botswana gained independence in 1966 almost concurrently with the discovery of diamonds. Botswana continues to be governed under a very stable political and economic environment. Immediately after independence there were some significant discoveries of minerals, specifically diamonds, copper and nickel resources. Subsequent to these discoveries Botswana developed the 1977 mining code which was replaced with the 1999 mineral act and regulations (Matshediso, 2005). Botswana is richly endowed with mineral resources with the occurrence of various mineral commodities within its jurisdiction. Prospecting for diamonds and other mineral commodities is continuing throughout the country, both by the Government and the private sector. Botswana produces diamonds, coal, soda ash, copper, nickel, silver, gold, industrial minerals and semi-precious stones. Other known deposits are uranium, iron ore, coal-bed-methane and platinum group metals (PGMs). Prior to the discovery of minerals, Botswana was one of the poorest countries in Africa and following the advent of mineral discovery, with the country one of the leading diamond producers by value, the country was catapulted to an economic powerhouse almost surpassing Asian tiger economies in terms of economic growth between the 1990’s and 2000’s. Diamonds are therefore a strategic mineral 41 resource to the government of Botswana and their taxation rates are negotiated between companies and the government. Botswana’s economic growth and political stability has often been referred to as “an African Miracle” owing to Botswana’s avoidance of the resource curse phenomena (Pegg, 2010). The International Monetary Fund (IMF, 2007) argues that Botswana benefitted from good governance practices as well as occurrence of abundant diamonds to boost economic growth. Between 1995 and 2005, the mining sector contribution towards the GDP peaked at 34.5%, with diamonds constituting nearly 94% of the country’s export value. However, the contribution towards GDP is now in a diminishing state of return at an estimated 17.8% in 2015 and 15.2% in 2019 (Statistics Botswana, 2020). Diamonds are projected to deplete just beyond 2030 hence the need for authorities to develop economic diversification programmes to create new sources of income for the country. Predating the discovery of diamonds and copper and nickel mines in Botswana, mineral discoveries were in existence in small mining towns albeit in small quantities (Gwebu, 2008). These minerals entailed gold, manganese and asbestos which were discovered in various districts within Botswana. Over the years, the booms from mineral exploitation stagnated the agricultural sector with continued importation of food from neighbouring countries. According to the United Nations Research Institute for Social Development (UNRISD, 2008), the economy of Botswana was initially reliant on the agricultural sector and heavily dependent on foreign aid. However, the advent of mineral discovery led to rapid economic growth with special emphasis on diamonds as strategically led by the state in a liberal market and a multi-party democracy. Following minerals discovery in the early 1960’s, the first Botswana’s mineral policy is yet to be fully endorsed by parliament. This is despite the fact that the formulation process of this policy was initiated in 2010, subsequent to the 2008 global economic downturn, with the view of attaining maximum utility out of the remaining mineral resources. (Ministry of Mineral Resources, Green Technology and Energy Security, 2017). 42 The government of Botswana continues to invest in mineral exploration activities with the main objective of attracting investment through reduction of early mineral exploration costs including conducting a detailed aeromagnetic survey for over 80% of the country (Ministry of minerals, 2017). However, part of the country remains unexplored with locked value in untapped mineral occurrences and given the limited financial resources, the challenge remains to create an enabling environment for private sector-led exploration and development of the untapped mineral resources of Botswana in a sustainable and transparent manner. The mineral sector is to position itself for continued significant contribution to future economic growth and development in alignment with economic development strategies of the government of Botswana. Botswana mineral development strategy is inclusive of diversification plans within the mineral sector to facilitate and promote development of various mineral commodities to widen the revenue resource base. The current revenue resource base is dominated by revenue generated from diamond exploitation activities alone, through mineral taxation and shareholding negotiated agreements. It is therefore in the interest of Botswana to unlock value in existing mineral resources including the confirmed multi-million Pula uranium deposit project which has been delayed for over three years. The off-take of these uranium mining projects was greatly affected by the collapse of uranium markets worldwide. Further, the Botswana Institute for Development Policy Analysis (BIDPA, 2012) opines that Botswana has an estimated potential coal deposits of 212 billion tons, probably the largest in Africa presenting a great potential for the country to diversify away from a diamond dependent economy. There are however some rail infrastructural developments to link production sites to the coast for export and South African markets. Although the window of opportunity is still open, the long term opportunity for Botswana could be hindered by the current effort to shift away from fossil fuels to green energy sources. Another avenue that the country is harnessing towards managing the mineral resources of the country is to develop the national capacity in the form of human skills and competencies 43 development and acquisition of technological advances required within the mineral sector. This entails creating an enabling environment for mining investors through provision of skilled labour. The country has focused on human capital development in areas of mineral taxation administration as well as mining operational professions. This is envisaged to address the perceived mineral taxation leakages particularly in transfer pricing arrangements between the government and its partners such as the DeBeers Group. 3.1 Botswana’s economy Botswana was classified as one of the poorest countries at independence in 1966, it rapidly became one of the world’s economic development and growth success stories as a consequence of mineral discoveries. Prior to that, Botswana had only 12 kilometers of tarred road, with only 22 citizens having graduated from universities and only 100 citizens who had attained secondary level education (Hillbom, 2013). To date, Botswana is one of the longest liberal democracy in Africa with good governance, record and market based economy (UNRISD, 2008) As a country that is well endowed with mineral resources, the government of Botswana has implemented various strategies geared towards economic growth and development through diversification of its economy. The country’s development path avoided the resource curse phenomena and the “mineral led economy syndrome” – the Dutch disease (UNRISD, 2008). Some scholars claim that although Botswana is an economic growth miracle, it has not experienced some economic structural change away from being reliant on mineral revenues. (Hillbom, 2008) asserts that Botswana has not yet experienced “modern economic growth” characterised by structural change in patterns of production as well as social and political institutions. The analysis explains the difference in terms of the economy and society, with significant economic growth as opposed to development which allows for significant poverty rates and extremely unequal resource and income distribution in the midst of plenty. As a middle income economy that is stable, Botswana boasts of low interest rates, a low inflation rate, and a stable exchange rate which is vital when dealing with the sale of minerals and products. 44 Botswana capitalised on the wind of nationalization sweeping across developing countries and Africa where the government negotiators’ leverage resulted in a 50 percent shareholding with De beers and good reason for investors to prevent outright nationalisation (Gaolatlhe, 1997). Afraid of the consequences of nationalization, the mining company was willing to offer more shares to the Government of Botswana that took advantage of the situation to negotiate for a greater share of the mineral wealth (Harvey and Lewis, 1990). The outcome of the negotiations was a mutual relationship between the Government of Botswana and De Beers with company operational management entrusted with De Beers to avoid pitfalls made by countries like Zambia. However, the diamond revenues on which the country depends is likely to decline in the near future (Harvey, 2015) affecting the economic base of the country primarily due to the susceptible nature of commodity prices to price fluctuations and the depleting nature of mineral resources. Botswana is therefore at a critical juncture to diversify its economy away from minerals and invest in more proficient broad based human and physical capital for the future. While some scholars opine that Botswana’s comparative advantage is still embedded in the diamond and base metal endowment, it ought to be underscored that the continual existence of minerals cannot be guaranteed due to their finite nature, hence the imperative to diversify the economy away from a mineral based economy. Mineral rich economies tend to become increasingly dominated by a syndrome in which three factors interact, namely high bias against agriculture and export diversification. This factor is true about Botswana where the agricultural sector has been relegated to lower levels of contribution to Botswana’s GDP since realization of increased revenue from mining exploitation activities. Auty (2001) argues that agricultural production is constrained by low and unreliable rainfall with sandy soils that favour livestock farming and wildlife management, a factor that has also somewhat contributed to the shift in the economic mainstay from agriculture to mining exploits. According to Usui (1997), comparison of the Dutch disease problem between Mexico and Indonesia through policy options adopted during periods of oil booms in both countries yielded contrasting results. Indonesia implemented sound economic policies including fiscal, 45 borrowing and exchange rate to avoid the outcomes of the Dutch disease. Mexico lost an opportunity to benefit from her resources as a consequence of her policy options. (Usui, 1997) assets that are equally important is the investment use of oil revenues to strengthen the tradable sector and diversify the economy is another factor for the success of Indonesia. Notwithstanding the fact that the country has avoided most of the negative effects associated with a booming natural resource sector, it has failed to diversify from diamonds to achieve structural changes towards higher value activities within the economy (Barczikay, Biedermann & Szalai, 2020). Botswana’s tourism sector has consistently been the second most contributor to Botswana’s GDP, tourism is therefore a source of ultimate renewable revenue stream (Harvey, 2015). It is in the interest of Botswana to promote environmental sustainability and preserve its pristine wilderness. The deliberate strategic shift from the government to boost the agricultural sector and other sectors of the economy from mineral revenue has not generated the desired results of economic transformation. The implementation of special agricultural programs and special economic zones over the years are yet to yield results that indicate that the depleting mineral asset will be successfully replaced. Perhaps the development of Botswana’s mineral policy will attempt to address economic transformation insufficiencies through involvement of stakeholders from various industries within the economy. Botswana’s mineral beneficiation efforts are currently focusing on diamonds alone with almost non-existent beneficiation plans for other mineral commodities. These may prove to be detrimental to the government’s effort to maximize returns from mineral exploitation activities as it is currently losing out on revenue generation from the beneficiation of other mineral commodities. Most base metal mines in Botswana are either at their youthful stage or at a commissioning stage granting the government an opportune time to derive base metal beneficiation plans resulting in creation of both employment and taxation of associated industries. Botswana’s public investment was geared towards rectifying the country’s backlog of economic infrastructure and to improving education and health systems. Although Botswana is hailed as an African miracle due to the coexistence of good governance and abundant occurrence of diamonds that significantly developed the economy, there is evidence to support partial Dutch 46 disease in Botswana (Koitsiwe and Adachi, 2015). Botswana avoided most negative effects of its booming natural resource sector but have clearly failed to diversify from diamond extraction and achieve a structural change towards high value activities. Barczikay, Biedermann and Szalai (2020) states that around 20% of GDP and 85% of exports are generated from the diamond industry with the economy ranked low in terms of economic complexity and struggles with significant unemployment. Mogotsi. (2002) proposed that Botswana had suffered from a mild Dutch disease because of high unemployment at the start of the diamond boom. Economic stagnation in other important sectors of the economy, with special emphasis on agriculture and manufacturing continue to present challenges to a relatively narrow economic base of Botswana. According to Pegg (2010) Botswana has done about as well managing its resource wealth as could have been ideally expected but is unlikely to diversify its economy away from diamonds anytime soon. Auty (2001) argues that while Botswana has experienced success as a result of coherent economic policies with a resultant rise in social welfare, it is still premature to judge Botswana as wholly successful. Notwithstanding that, other drivers of the Botswana economy have emerged as indicated by a 19.6% contribution to the GDP by the Trade, hotels and restaurants sector ahead of the mineral sector at 18.1% for the first time in history (Statistics Botswana, 2018). The structural change on the economy with improvement in Trade, hotels, and restaurants could be attributed to tourism-related to products of diamond beneficiation with people coming into the country to buy processed diamonds. The results are an indication of structural change in the economy to develop absorptive capacity and protect the economy against eventual shocks that will arise from the depletion of commodities, especially diamonds which are strategic to the country. Beneficiation of strategic minerals in Botswana is still to be improved with a sizable proportion of diamonds produced within the country still being cut and polished in the United Kingdom. Notwithstanding intentions by the Botswana government through appointment of a team tasked specifically for mineral beneficiation, revenue generated from fiscal, production and consumption linkages may be used to further promote economic diversification. 47 It is, however, necessary for Botswana to broaden and expand industries with comparative advantage within the country rather than reconfigure the whole economy and change the economic base. This will leverage and enable continuous improvement in sectors that already exhibit potential growth without structurally changing the whole economy. Jefferis (1995) asserts that Botswana’s manufacturing is however relatively undeveloped and comprises mostly small and medium sized companies. Deliberate policy decisions to develop and grow the manufacturing and other sectors of the economy are still to be fulfilled by the government of Botswana offering a window of opportunity for the revenue from minerals to contribute towards broadening the economy for sustainable development and to benefit future generations. Botswana’s other diversification enhancing policies have had limited success as set up in their different special economic zones. One such special economic zone is the SPEDU region (Special Economic Diversification Unit) is located in the central district of Botswana and is mandated with diversifying the economy away from over reliance on the mineral sector. The Government of Botswana set up these special economic zones in various places within the country with the intention to support industrialisation through the economic sectors of tourism, manufacturing and agribusiness. The tourism industry has been performing fairly well but the manufacturing and agribusiness are falling short of their mandate with Botswana still not self-sufficient on food security. Further, the reliance of the economy on natural resource wealth is often not coupled with a strong focus on human cap