Zambia U-turn makes mountain of investment

[] – FEW tax hikes have been timed so badly – and retracted so fast – as that imposed on mineral royalties by Zambia’s President Edward Lungu in January.

After threats of divestment from major mining houses and an outcry from the country’s Chamber of Mines, the massive hike in royalty taxes was reversed.

In addition, onerous bureaucratic demands for export documentation – that had resulted in millions of dollars in VAT returns being bottlenecked – were also amended.

However, some analysts believe that the damage has already been done.

Owing to the anaemic demand for commodities, many companies have cut back on production and few are willing to take a chance on investment in a country in which mineral tax policies cannot be relied on.

Several companies have put expansion plans and mooted projects on hold, at least until after next year’s election.

According to Will Pearson, managing director of strategic advisory services firm Triskel Africa, proposed investments in the mining sector are largely static despite expansion plans mooted before the single-tier system was introduced and VAT refunds were withheld in 2014.

While Lungu had not made overt promises regarding policy in his January campaign, he is likely to stand again next year. Given his razor-thin majority, he is certainly no shoo-in, and should the opposition United Party for National Development (UPND) take power, new policies are likely to again be negotiated.

Lunga’s Patriotic Front Party, which snatched victory by a nail biting 1.6% from opposition party UPND in January, came into power with few promises other than to entrench his predecessor’s populist policies.

The famously abrasive Michael Sata, who died in October last year, was focused on improving the lot of deeply impoverished Zambians through expensive food subsidies and infrastructure development.

In addition to a series of Eurobond issues, funding for these projects would come partly tax hikes for mining companies.

The new mineral royalty policy, drafted under Sata’s leadership, and released in October 2014, was met with howls of derision from the mining industry, already battling to access $600m (R7.5bn) in VAT returns, and negotiating an increasingly erratic and feeble kwacha and floundering copper prices.

According to Zambian Chamber of Mines economist Shula Shula, during the more benign 2014 tax regime, nine out of 11 copper mining operations had already been loss-making.

The new “simplified’ royalty structure also did away with the 30% corporate income tax other than for downstream processing operations. This tax was in any case simply ‘illusory’, according to finance minister Alexander Chikwanda, since as of 2013 only two companies – First Quantum and Gemfields – were paying it.

Chikwanda accused the industry of hiding taxes through “schemes’ such as transfer pricing, hedging and trading through “shell’ companies which are not directly linked to the core business.

Chikwanda says that even when copper prices were soaring the country had not realised “maximum benefits’. He points out that despite the country’s significant mineral deposits, the mining sector contributed just 4% to GDP – this even after Sata increased tax from 3% to 6% in 2012. He says that since mineral wealth was “non-replenishable’ its value should be redeemed for future generations.

Despite forecasts that the new royalty taxes would halve the foreign direct investment associated with the industry, it was implemented on 1 January.


On 23 January, the copper price dipped to a five-and-a-half-year low of around $5,353 a tonne, below the estimated average marginal cost of production of $5,500/t.

This estimate is higher than the marginal costs of older, deeper Zambian mines, which are more expensive to operate.

The copper price in January was a more than 44% drop from 2011 when it reached a spectacular $10,000/t. The metal traded at between $6,435/t on 5 May and $6,117/t on 27 May.

But largely because of threats from major mining houses to stall investment or even disinvest – and the potential economic calamity this would cause – the controversial royalty tax was officially shelved just three-and-a-half months after it was imposed.

On 20 April, cabinet approved the re-introduction of the previous tax system, albeit with the mineral royalty on both underground and open-pit operations pushed to 8%. The “illusory’ 30% corporate income tax was also reinstated.

Barnaby Fletcher, an analyst at global risk consultancy Control Risks, says that despite the fiery rhetoric, the government actually began negotiations with the mining sector, often behind closed doors, in at least early December.

This clearly indicated a willingness to compromise despite going ahead with the implementation of the new regime.

Nonetheless, outrage from industry players including the Chamber of Mines and mining houses gathered force after the law was implemented.

In late January, the chamber issued a statement saying that the new tax policy was “alarming for the state of the country’s economy’ since, compounded by the barrel-scraping copper and resource prices, it would invariably lead to mine closures in “both the short and medium term’.

The chamber says that since Zambia’s entire mining industry accounts for around 86% of the country’s foreign cash inflows, the demands would be devastating.

At the same time major miners including Barrick Gold Corporation and Vedanta issued statements to shareholders that they were preparing to shut up shop.

First Quantum Minerals, which owns 80% of Kansanshi mine through its subsidiary Kansanshi Mining, declared that it would delay more than $1.5bn (R18.8bn) in Zambian investments due to concerns over the new taxation regime.

Canada-based Barrick Gold Corporation, the world’s largest gold-mining company which owns the R1bn Lumwana copper mine, told shareholders the company could not continue operating there if the tax was implemented.

Barrick co-president Kevin Dushinsky announced the suspension, saying that “the introduction of this royalty has left us with no choice but to initiate the process of suspending operations at Lumwana’.

He says the economics of Lumwana – reportedly producing at $5,000/t at the mine – could not support a 20% gross royalty, particularly in the current copper price environment.

The potential loss of Barrick posed a serious threat to the regional economy. In its January statement, the chamber pointed out that Lumwana was a “major driver of the North-Western Provincial economy, purchasing close to $400m [R5bn) in goods and services from Zambian suppliers in 2014, and supporting a range of education, literacy, health care and community projects’.

Suspending operations at Lumwana would also have impacted three smelters on the Copperbelt which depend heavily on it.

Last year, Barrick mined 62.6 million tonnes of copper from Lumwana, much of which was beneficiated in the Copperbelt. Since the retraction of the royalty tax, Barrick announced it would continue to operate the mine.

We are not overly nervous about Zambia, but we aren’t stupid about it either

London-listed Vedanta Resources – whose subsidiary Konkola Copper Mines (KCM) is Zambia’s largest copper mining company – also considered its options after the royalty was imposed. Vedanta CEO, Tom Albanese, who previously headed up Rio Tinto, said in January that it would cut capital expenditure in its copper business in Zambia.

Despite encouraging remarks over the royalties, tough decisions would still have to be made by his company. The company has invested over $2bn (R25bn) into its operations over the last five years.

Vedanta says that the new tax regime would cost it $15m (R188m) in core earnings in the first quarter this year, threatening the sustainability of jobs for its 8 000 staff in Zambia.

Global financial services and advisory company Morgan Stanley says that should Zambia not temper its stance on royalties, Konkola Copper Mines would be worthless.

According to Triskel Africa’s Pearson, continued policy uncertainty in Zambia will likely persist through the next national election in September 2016, which may lead mining companies to pursue opportunities elsewhere in the meantime, including in neighbouring Democratic Republic of Congo, which became Africa’s largest copper producer in 2013.

Ian Harebottle, CEO of gem mining company Gemfields, was more upbeat about the policy environment, saying that “law and order were in place, and common sense had always prevailed’.

He hedged his bets though: “We are not overly nervous [about the environment becoming less investor friendly], but we aren’t stupid about it either.’

He says that one of the benefits of Gemfields is its global footprint, which means that the company isn’t entirely reliant on what happened in Zambia or anywhere else.

The Chamber of Mines estimated that as a direct result of the introduction of the budget in 2014, mine suspensions and the postponement of major capital projects will lead to over 12 000 direct job losses. Employed Zambians are estimated to support 10 people each.

But royalty increases haven’t been the only tax problems the industry has faced recently.

Zambian authorities infuriated mining companies by refusing to pay out around $600m (R7.5bn) in VAT refunds without import certificates from destination countries proving that the requisite taxes had been paid to Zambia.

Exporters were also forced to prove that their export proceeds had been deposited into a bank account in Zambia in order to claim the refunds.

But since many companies sell directly to multi-national trading houses, knowing the destination country was virtually impossible.

Glencore, a commodity trader as well as miner,- claimed that it was owed $200m (R2.5bn) in VAT and threatened to halt copper mining projects worth $800m (R10bn).

Zambian Revenue Authority commissioner general Berlin Msiska says that it would now accept transit documents from exporters claiming VAT refunds. But while this would no doubt make things easier for exporters, it isn’t going to help free up money that is already blocked in the system.

In March, Msiska said mining companies that wanted to access accumulated VAT refunds would still have to produce export documentation because “law is law’.