Commentary: A better response to Mexico’s new mining taxes

The recently introduced mining tax regime in Mexico has been widely criticized by mining company executives, the business press, and a variety of mining lawyers, newsletter writers and consultants. The reform includes a 7.5% royalty along with increases in corporate tax rates and other changes affecting this sector.

The commentary has ranged from understandable (yet another cost at a time where the industry is already under severe challenge) to the obvious (it changes the rules for companies) to the strident (it undoes every other advantage that made Mexico a preferred jurisdiction for Canadian miners in particular for many years).

But understanding the context of the changes is a more constructive response to what is now a done deal.

The introduction by the Mexican federal government of the new mining taxation regime should have been expected: it has been in the making explicitly since at least 2010, and represents a natural realignment of the measures taken 20 years ago to open the sector to foreign investment, to the benefit of many Canadian miners. It means that Mexico joins Argentina, Australia, Brazil, Chile, Colombia, Peru, Russia, South Africa and the U.S., among others, as mining royalty regime countries. And forgotten in the flood of criticism is that as much as 60% of the royalty amount will be tax deductible.

Suggesting, as many commentators have, that the change was driven by short-term economic or political imperatives is too narrow a view, and bemoaning the new mining taxes as an added cost is too short-term a response. Looking at the new tax regime as another example of Latin American “resource nationalism” is to misunderstand it entirely.

The new mining taxes in Mexico are an integral part of a large-scale tax reform which is critically needed to improve what has been for many years an unsustainable tax base.

To give an idea of the problem, Mexico’s tax revenue as a proportion of gross domestic product lags that of Organisation for Economic Co-operation and Development countries by a whopping 60%. (The OECD is one of several international organizations that has for some time urged Mexico to reform its tax base).

Without broad federal tax reform, most agree Mexico will remain at risk of serious financial, economic and ultimately social dislocation, especially since federal taxes in Mexico account for 98% of the country’s tax revenue — more than double what it is in Canada.

The Mexican government has introduced a range of new revenue-producing measures across most aspects of the national economy, right down to video games. The implementation of this larger package has been driven by the urgent need for the federal government to bring its revenues in line with its GDP and wean the country off its over-reliance on rapidly declining oil for its revenues.

(It is no coincidence that Mexico also introduced an historic oil and gas reform package which upturned a legal scheme in that sector that had been in place for decades. What was an unfortunate coincidence was the mining tax reform being introduced during the global mining downturn.)

The mining sector in Mexico is 70% foreign-owned and most of this is in the hands of Canadian companies. Mining production in Mexico has been skyrocketing, up 50% in 2010, and more than double in the ten years ending in 2010 what three centuries of mining by the Spaniards produced.

Today, eight out of the top 11 gold producers in the country are Canadian, and gold production was up 118% between 2007 and 2012.

Yet taxes from this sector in Mexico prior to the recent reform were a mere 1% of production.

The Mexican government did not introduce this latest reform lightly. Before acting it looked carefully at tax regimes in other jurisdictions, including Canada.

Surprisingly to some, it found that taxation rates in the sector when considered against profits were as much as 70% higher in other countries, including Canada.

Against this background, it is understandable why the announcement of the new mining taxes had little effect on the share prices of Mexico’s majors.

The price of being able to profitably extract natural resources from developing countries is that from time to time foreign investors will be called on to share the burden of larger social development in various ways — and not all of them fair. This has been the clear trend in resource exploitation everywhere for centuries.

We must not lose sight of the fact that Mexico did not nationalize its resources or change its land tenure regime. It did not impose restrictions on foreign ownership in the sector, nor did it impose burdens not already in place in many other similar mining jurisdictions.

Mexico’s new taxes on mining are a well-justified piece in a package intended to ensure the country can continue to move along the path to becoming an important player in the world economy and a key partner to Canada and others through its network of free trade agreements, the largest in the world.

The new mining taxes should be looked at in particular by Canadian miners through the lens of corporate social responsibility as an investment in the long-term sustainability of Mexico as a favoured mining jurisdiction.

In the barrage of negativity, few thought to ask where this new revenue was going to go and so many missed a key feature of the tax reform as it relates to mining: only 20% of the new mining-derived revenue is going to the federal treasury, with the rest allocated by law to the states and municipalities where mining takes place — with the lion’s share going to municipalities.

This is a kind of distributive taxation unfamiliar to many. It is also an intelligent way to gain better acceptance of the less-desirable effects of mining among those most affected — a sort of compulsory fee for the company’s social licence.

Mexico’s tax reform isn’t perfect. No country has found a perfect way to balance the needs of investors with those of government.

Mexico’s tax reform is not as comprehensive as it would seem to Canadians it should be. But then again Canada does not have to deal with a third of its population living in abject poverty, dependent on government-subsidized food, energy and fuel for daily survival, nor with rates of tax evasion in some sectors reaching 40%.

Outsiders may underestimate the challenges of implementing any kind of serious reform in Latin American countries. Mexico’s changes are ambitious and much-needed after so little progress having been achieved since the 1980s.

Most importantly, the wider reform of which mining taxes are a part, is the result of a years-long and delicate political dance among notoriously difficult to reconcile and disparate sets of interests.

In Mexico, history has shown that the price of not acting, just as much as the price of overreaching, can be political instability and unrest.

— Ralph Cuervo-Lorens is a Mexico born, Toronto-based lawyer who leads the Mexico and Latin America Group at Blaney McMurtry, LLP. Fluent in Spanish, he assists Canadian mining companies in risk management, regulatory compliance, permitting and country risk assessment in relation to their operations and activities in Mexico. See www.blaney.com for more.