Averting the

Resource Curse
Path to Prosperity
Project Mongolia
A World Growth Report

April 2008
Table of Contents

1. Introduction ........................................................1 5. Implications for Mongolia ................................25

2. Executive Summary............................................3 6. Conclusion ........................................................35

3. Optimizing Mining’s Contribution to Annex A ....................................................................41

Economic Development ......................................7

4. Lessons from International Experience ..........15


Mongolia is a developing country that is heavily dependent upon its mining sector, which is
directly responsible for nearly one-fifth of the country’s GDP, two-thirds of its industrial
output, three-quarters of its export earnings and one-half of its public revenue.
According to Mongolia’s Foreign Investment and
Foreign Trade Agency, the Mongolian mining sector
received nearly $200 million in foreign direct invest-
ment (FDI) in 2006, compared to just $40 million in
2002; thereby accounting for nearly half of all FDI in
Mongolia in 2006. Despite this investment, the sector
contributed only 4 percentage points to the country’s
economic growth in 2007 and its contribution was
largely due to increases in world-wide minerals prices.
Mongolia’s geological prospects are very bright. It has
world class mineral deposits that are ripe for develop-
ment — such as the Oyu Tolgoi copper and gold proj-
ect and the Tavan Tolgoi coal project — but they are
often in remote and commercially challenging loca-
tions. Their successful development will therefore
require considerable amounts of capital and sophisti-
cated mining know-how, most of which will have to be
sourced internationally.
The Mongolian tax, regulatory and institutional envi-
ronment exerts a profound influence on the returns
that international investors can expect from in-coun-
try mineral development. The quality of the local pol-
icy environment in terms of its attractiveness to
investors is therefore critical to Mongolia’s future eco-
nomic development and mining role in that future.
Favorable geology must be accompanied by balanced
and compatible policy to enable a viable mining
industry to be achieved.
This paper will canvass the requirements of a mining
policy framework for Mongolia that would deliver
international best practices in terms of investment
attraction. In doing so, the paper will focus on the
prospects and opportunities of the Oyu Tolgoi project,
using a three-part approach.
INTRODUCTION
INTRODUCTION
First, the paper will articulate the principles for devel-
oping a policy framework that will optimize the mining
sector’s contribution to Mongolia’s economic develop-
ment. In doing so it will canvass the issues of mining
taxation and regulation, the provision of infrastructure
services to the sector, macroeconomic stability, distrib-
uting the benefits of mining and sovereign risk.
Second, the paper will review recent international expe-
rience through the prism of these policy principles. The
review will consist of two distinct but complementary
components: a high level cross sectional review of
recent results of surveys of investor perceptions; and
three case studies of mineral-rich, developing countries
with quite different experiences with mining policy
reform. A set of best practice policy measures and s
ettings will be synthesized from the review..
Finally, the paper we will draw on this best practice to
highlight the key policy changes that Mongolia should
adopt for mining generally and the Oyu Tolgoi project
in particular. Oyu Tolgoi could be the largest gold and
copper mine in the world, but needs massive capital
investment to realize this potential. The project is a
litmus test for the Mongolian mining tax and regula-
tory regimes and for the Mongolian government’s
proposals to ‘lock in’ key policy parameters for the
project in an investment agreement with its investors
and license holders.
Their successful development will therefore require
considerable amounts of capital and sophisticated
mining know-how, most of which will have to be
sourced internationally.
Mining Report on Mongolia — Averting the Resource Curse • 1
2 • Mining Report on Mongolia — Averting the Resource Curse
 EXECUTIVE SUMMARY

Mongolia is in the process of transforming itself into a nation that is based on secure prop-

erty rights, economic freedom and democratic government – and even though it has lost its

EXECUTIVE SUMMARY
way in that regard over the past several years it is believed that it can and will get itself

back on course. A major test of the progress it has made, as well as its resolve to continue

with that process, will be how it handles the challenge represented by Oyu Tolgoi, a mas-

sive, world class mineral deposit located in the remote South Gobi region of Mongolia, near

the China border.

Mongolia Needs Oyu Tolgoi to Proceed
Oyu Tolgoi has the potential to become the world’s
largest copper and gold producer, but realizing that
potential will require investment on a scale that is
unprecedented, certainly for Mongolia. Once under-
way, the project stands to generate substantial eco-
nomic benefits for Mongolia via its contributions to
gross domestic product, employment, exports, infra-
structure and public revenue. But these opportunities
may all be lost if the window for development of the
mines at Oyu Tolgoi miss the commodities market
since such large mines cannot be built overnight.
Ivanhoe Mines, the owner of the Oyu Tolgoi mineral
licenses, proposes to invest in excess of US$7 billion in
the project over a period of 35 years. More than half of
this amount would be committed in the first 15 years
of the life of the project.
Mining investment, particularly on this scale, is huge-
ly sensitive to the quality of the institutions and the
policy framework that exists in the host country. The
policy framework consists of the taxation and regula-
tory arrangements that the host government imposes
on the mining sector. The greater the economic bur-
den that is placed on mineral exploration and devel-
opment, the less attractive the country will be to inter-
national mining companies.
… but Mongolia Discourages Investors
early in its transition, of a modern legal architecture,
with which to tax and regulate mining. Sadly, many
significant practical details were left for later develop-
ment but have never been completed. More unfortu-
nately, the most recent policy innovations have begun
to reverse the earlier progress.
Put simply, the current institutions and the policy
regime in Mongolia are not internationally competi-
tive in terms of attracting and retaining mining
investment, and it is a long way from being so. Its lack
of competitiveness represents a major economic cost
for ordinary Mongolians who seek jobs and a better
way of life, given the economy’s present reliance on
agriculture and the country’s inability to capitalize on
its rich geological potential.
The gap in international competitiveness has been
highlighted by a recent survey of mining companies
around the world. The Fraser Institute asked the com-
panies to rate the policy regime in 68 mining jurisdic-
tions around the world.
In 2007-08 the companies surveyed ranked Mongolia
as the 8th worst of the 68 countries in terms of invest-
ment attractiveness. This is in sharp contrast to other
mineral-rich developing countries, such as Chile and
Botswana, which were at the top of the rankings.
Papua New Guinea, on the other hand, has shown
how even highly selective reforms, when well target-
ed, can dramatically improve a country’s standing.

Mongolia has made commendable progress in trans- Part of Mongolia’s problem is the poor quality of some
forming itself into a democracy and free market econ- of its institutions, such as those concerned with secur-
omy. This progress has been reflected in its adoption, ing property rights and preventing corruption. For

Mining Report on Mongolia — Averting the Resource Curse • 3

 example, the Heritage Foundation’s Index of
Economic Freedom report for 2008 noted that the
enforcement of laws protecting private property was
weak in Mongolia and its judges generally did not
understand commercial principles such as the sanctity
of contract. Moreover Transparency International
ranked Mongolia 99th out of 163 countries on its 2006
Corruption Perception Index. The latter was due, in
part, to allegations of public sector corruption that, in
some cases, appeared to involve cabinet-level officials.
Corruption, incomplete or insecure property rights,
and absence of the rule of law inhibit Mongolia’s abili-
ty to profit off of its extensive mineral resources.
On the basis of independent research, Professor
Otto has estimated that the current regime in
Mongolia captures nearly 70 percent of the gross
profitability of a representative large-scale copper
mine. This is twice as much as occurs with interna-
tional best practice.
The competitiveness gap between the Mongolian pol-
icy regime and international best practice has been
quantified by Professor James Otto, an international
expert in mining taxation and regulation. On the basis
of independent research, Professor Otto has estimated
that the current regime in Mongolia captures nearly 70
percent of the gross profitability of a representative
large-scale copper mine. This is twice as much as
occurs with international best practice.
Given the overall tax burden under the Mongolian
mining tax regime, Professor Otto estimated that the
internal rate of return to a foreign mine owner would
be less than 8 percent per year. This is just over half
the minimum rate of return that international mining
companies expect from such investments and not suf-
ficient to entice any western mining company to
invest large capital or to do business in Mongolia.
Taxation aside, there are two serious flaws in the reg-
ulatory regime for mining in Mongolia. One involves
the creation of the concept of a “Strategic Mineral
4 • Mining Report on Mongolia — Averting the Resource Curse
Deposit”. The other concerns the legal alternatives for
the government to compulsorily acquire substantial
equity interests in such Strategic Mineral Deposits
without remotely coming close to paying anything
related to fair market value for such interests. At the
same time, the government would continue to regu-
late the very mineral projects in which it has equity
interests. In fact, in a heretofore unprecedented move,
the Mongolian government recently announced that
it would obtain a 96 percent equity interest in the
Tavan Tolgoi coal deposit.
The mere possibility of the government doing so is a
significantly negative factor from the perspective of
international mining investors. This would increase
the international perception of the risks of investing
in Mongolia and thereby reduce the amount of inter-
national capital available for investment in the coun-
try. In such circumstances, the government as well as
the people of Mongolia should ask themselves what
western mining company would risk investing sub-
stantial funds in exploration activities that may result
in the discovery of a commercial deposit only to have
the government take it away – or at least a substantial
portion of it?
Draft Investment Agreement only a
Partial Solution
To make Oyu Tolgoi a reality, the Mongolian govern-
ment has been negotiating with Ivanhoe Mines and
Rio Tinto to conclude an investment agreement.
These negotiations started in late 2003 and are con-
tinuing to the present time. The current Minerals Law
allows such agreements to ‘lock in’ key tax and fiscal
issues and regulatory parameters for establishing a
mining project for up to 30 years or more.
The government’s latest proposals for the draft agree-
ment have a major advantage. They would effectively
eliminate the most serious shortcoming of the
Mongolian mining tax regime — the 68 percent tax on
‘windfall’ profits — albeit at a cost to the company and
the country.
The windfalls profits tax is without precedent else-
where in the world and is the major reason behind
Mongolia’s lack of investment competitiveness. So-
called ‘windfall’ profits perform an essential function.
They reward the entrepreneurial effort that brings
together the capital and sophisticated knowledge,
which is the foundation of successful minerals devel-
opment. Taxing this incentive makes no sense. It only
reduces the flow of investment and may destroy it
completely.
Unfortunately, eliminating the windfall profits tax in
the context of the proposed agreement would unneces-
sarily restrict the economic benefits to Mongolia from
the reform. The more desirable solution would be to
repeal the tax completely. No repairs can be made to
such a tax law as the concept is fundamentally flawed.
Elimination of the windfall profits tax for Oyu Tolgoi,
however, will come at an apparent cost to the compa-
ny and to Mongolia, although the extent of that cost is
unclear.
To avoid imposition of the windfall profits tax, the
Mongolian government has proposed that Ivanhoe
must have a 500,000 tonne copper smelter built in
Mongolia within five years of the commencement of
mining operations at Oyu Tolgoi. In the absence of
any legislative restrictions or mandates, a smelter
would ordinarily be built only if it makes commercial
sense. There would be no net economic benefit to
Mongolia in forcing an uneconomic investment on
Ivanhoe or anyone else, including the Mongolian gov-
ernment. It would simply divert capital from more
rewarding applications, such as the subsequent
expansion or upkeep of the proposed mines.
The windfall profits tax aside, the government’s other
proposals for the investment agreement would
entrench the serious flaws in the Mongolian regulato-
ry regime. These relate to the legislative option for the
compulsory acquisition of some, if not all, of the equi-
ty in a mineral project by the Mongolian government:
Although the relevant regulations have yet to be
developed, the government’s proposals for the agree-
ment envisage it acquiring 34 percent of the equity in
Oyu Tolgoi without any payment close to present fair
market value. Moreover, the government has subse-
quently suggested that the acquisition level should be
raised to at least 51 percent. The terms of any acquisi-
tion have yet to be agreed between the parties.
… as any Equity Acquisition would be a
Serious Mistake
The acquisition of an equity share in the Oyu Tolgoi
project would be viewed negatively by international
mining investors. More importantly for Mongolia, it
would put at risk the substantial economic benefits
that the project would deliver for the Mongolian com-
munity as a whole.
Regardless of how the terms for the acquisition are
eventually reached, this would increase perceptions of
the risks of investing in Mongolia and reduce the
amount of capital for investment in the country.
Acquisition would also undermine the financial via-
bility of the project, increase the risks associated with
it, and potentially complicate its management. These
impacts would lower the value of equity in the project,
which would be reflected in a reduction in its prof-
itability and in the net present value of the dividend
and public revenue streams from it.
Partly for this reason, most countries have realized that
the standard corporate income tax is a much less risky
and more effective way of ensuring that the communi-
ty as a whole shares in the benefits of mining develop-
ments. There is no empirical evidence that acquisition
or equity participation would yield more revenue for
the public purse, quite the contrary, in fact.
Finally acquisition would create a serious conflict of
interest for the government. It would be expected to
regulate mining at Oyu Tolgoi in the public interest.
At the same time, it would have a strong financial
interest in not doing anything that would reduce its
profitability.
Any exercise of the acquisition option in the case of Oyu
Tolgoi would be seen as increasing the risks of mining
investment in Mongolia more generally, which would
have negative consequences for mineral exploration
and development. This perception will have been rein-
forced by the government’s proposal to completely
nationalize the Tavan Tolgoi coal mine and would be
reinforced further if the government completes that
acquisition.
Mining Report on Mongolia — Averting the Resource Curse • 5
6 • Mining Report on Mongolia — Averting the Resource Curse
3. Optimizing Mining’s Contribution to
Economic Development
Mining is a source of wealth creation. The economic
surpluses that are generated by successful mining
developments drive private companies to explore for
minerals and develop mines to extract the ores from
them. In some cases, the surplus can be very substan-
tial, even after allowing for the risk-adjusted return
that investors require for them to proceed with an
investment. Such surpluses are known as ‘economic
rents’.1
The process of initial mineral exploration and subse-
quent mine development is generally economically
beneficial to a host country in two different ways.
them..3 Exploration can inform mining investment
decisions but it can never eliminate the profound
uncertainty that is part and parcel of every exploration
project and every mine development.
This chapter will outline the principles by which
countries can optimize the contribution that the min-
ing sector makes to their economic development.
Economic development is broadly conceived and
refers to development that benefits the community as
a whole, rather than simply one section of it. In doing
so, the chapter will concentrate on the principles of
most relevance to mineral-rich developing countries,
such as Mongolia.
3.1 Investment & Mineral Development

• Mineral exploration and mining generates addi-
tional economic activity. In the case of developing
countries, this generally takes the form of employ-
ing local people and using locally-produced goods
and services, i.e., building complementary manu-
facturing and services industries to support the
mining industry.
• Mining provides a host government with an oppor-
tunity to redistribute some of the economic rents
from mining by way of mining regulation and tax-
ation.2
To the extent that such redistribution does not alter the
incentives for mineral exploration and mining develop-
ment, the host country would be a net beneficiary and
the only losers would be the foreign shareholders of the
relevant mining companies. Successful mineral devel-
opment involves overcoming the inherent ignorance
and uncertainty about ore bodies and how best to
exploit them. The economic rents generated by mining
are the returns to the entrepreneurial insight, which is
essential to finding potentially valuable ore bodies and
then finding an economic way to extract the value from
Modern mining technologies are capital-intensive by
nature and need to be deployed at a large scale to real-
ize the significant economies of scale that they offer.
Mining developments also tend to occur in remote
and sparsely populated locations, which lack access to
basic transport, power and water infrastructure.
All of this means that successful mineral exploration
and mine development involves the mobilization and
deployment of large amounts of financial capital and
sophisticated know-how. For this reason, the global
mining sector is dominated by a relatively small num-
ber of international companies that are well-financed
and technologically advanced. They are also risk
averse, highly selective in the projects they undertake
and sensitive to changes in the investment climate
and government policy in which they operate.
Mining developments also tend to occur in remote
and sparsely populated locations, which lack access
to basic transport, power and water infrastructure.

1 The concept of ‘economic rent’ was developed by David Ricardo to analyse land-use in 19th Century Britain. It reflects the natural differ-
ences in productivity between different natural resources, such as mineral deposits. Such differences are a function of the cost of extrac-
tion and the price of the output.
2 A government can take part of the economic surplus generated by mining in a pecuniary form (as tax revenues) or in a non-pecuniary
one (as regulatory restrictions that add to production costs). Other things being equal, they have exactly the same effect on the incen-
tives for mineral exploration and development.
3 If mining were restricted to a risk-adjusted rate of return, the owners of the capital and labour used by the sector could be fully compen-
sated for their inputs but there would be nothing left for the entrepreneurial effort in bringing them together in the right combination,
in the right place, at the right time.

Mining Report on Mongolia — Averting the Resource Curse • 7

A United Nations/World Bank survey of international
mining companies has identified the decision criteria
which they use to evaluate mineral projects and
potential investments — Table 1 has the key results. In
addition to a host country’s geological prospectivity
and its mining tradition, this survey makes clear that
mining investors are particularly sensitive to:
• attractive and competitive fiscal conditions;
• clear mining rights and title;
• retaining ownership and control of mining
operations;
• availability of infrastructure; and political stability
and transparency of governance with sound and
supportive government policy.
Each of these characteristics of the investment envi-
ronment in a jurisdiction is a direct consequence of the
quality of the institutions in the jurisdiction and public
policy regime that it applies to the mining sector. In
other words, the greater the share of the economic sur-
plus that the government takes away from the
investors through its taxation, regulatory and institu-
tional arrangements and settings, the less incentive
they have to explore for minerals or to extract them
from the ground once they have been found. If the
investors’ share becomes too small, exploration for
new mineral deposits, reinvestment in existing mines
and development of new mines would cease complete-
ly. This would, of course, involve consequential losses
in employment and other economic activity that were
associated with these operations, some of which occur
outside the mining sector. It would be akin to killing
the goose that laid the golden egg.
From the economic perspective of the host country,
there is an optimal burden to be imposed on its min-
ing sector by way of the taxation, regulatory and insti-
tutional arrangements and settings under which the
sector is expected to operate. The international com-
petitiveness of such a framework is necessarily a
dynamic concept. Most mining jurisdictions around
the world are more or less constantly seeking reforms
to their policy framework to increase their ability to
attract mining investment. This means that policy
reform remains a continual process for most countries
rather than an ad hoc development.
4 The World Bank, 2004, Mongolian Mining Sector: Managing the Future, The World Bank, Washington, DC.
8 • Mining Report on Mongolia — Averting the Resource Curse
In practice, the principles that determine the optimal
public policy framework and settings are difficult to
determine with precision. This reflects fundamental
constraints on our knowledge of the relevant informa-
tion, such as how the individuals and companies in
question may be expected to react in response to par-
ticular changes in key prices and costs. Each of the
elements of this assessment is dealt with in the rest of
this chapter.
3.1 Taxation of the Mining Sector
The mining taxation regime needs to recognize the
unique characteristics of the mining industry. Mining
operations are generally:
• relatively high risk;
• highly capital intensive and often large in scale;
• cyclical by nature;
• conducted in remote areas which lack access to
basic infrastructure and a working population;
• characterized by long but finite project lives; and
• associated with significant restoration obligations
at their conclusion.4
The risk and cyclical nature of mining operations are
due to the long and uncertain lead times from explo-
ration to mine development, the significant sovereign
risk of mineral exploration and development, and the
substantial volatility in mineral commodity prices.
Any assessment of the implications of a mining taxa-
tion regime has to take into account how the regime
interacts with the general system of business taxation.
At the end of the day, it is the combined effect of the
two that really matters in determining whether a
jurisdiction is internationally competitive in attract-
ing and retaining investment. The issue for the taxa-
tion treatment of artisanal versus commercial mining
can also be important from a competitive neutrality
perspective.
3.1.1 Level of Mining Taxation
This section will focus on the combined effect of all
taxes, fees and charges imposed on the mining sector
by the legislature. It covers the taxes, fees and charges
levied on all business activity in a jurisdiction, includ-
 Ranking of decision criteria for investment by international mining companies
Table 1
Exploration Mining Decision Criterion

1 NA Geological potential for target mineral

NA 3 Measure of profitability
2 1 Security of tenure
3 2 Ability to repatriate profits
4 9 Consistency & constancy of mineral policies
5 7 Company has management control
6 11 Mineral ownership
7 6 Realistic foreign exchange regulations
8 4 Stability of terms for exploration & mining
9 5 Ability to predetermine tax liability
10 8 Ability to predetermine environmental obligations
11 10 Stability of fiscal regime
12 12 Ability to raise external financing
13 16 Long term national stability
14 17 Established system of mineral titles
15 NA Ability to apply geological assessment techniques
16 13 Method & level of tax levies
17 15 Import & export policies
18 18 Majority equity ownership held by company
19 21 Right to transfer ownership
20 20 Internal (armed) conflicts
21 14 Permitted external accounts
22 19 Modern minerals legislation

Source: James Otto, 1992, ‘A Global Survey of Mineral Company Investment Preferences’, Mineral Investment Conditions in Selected Countries of the Asia-Pacific
Region, United Nations ST/ESCAP/1197, pp. 330-342

ing mining operations, as well as those that are only
levied on mining operations.
The combined effect may be expressed in terms of the
effective tax rate (ETR). The ETR is the net effect of
all taxation provisions, including:
• income tax;
• dividend and interest withholding taxes;
• mining royalties;
• any taxes on ‘windfall’ or excess profits;
• export and import tariffs and excise duties;
• value-added or sales taxes;
• the taxation treatment of past losses, depreciation,
depletion allowances, exploration expenses, envi-
ronmental expenses, and mine closure costs; and
• tax holidays.
To facilitate comparisons on a consistent basis, ETR is
usually expressed as a share of gross operating surplus
(GOS) in national accounting or a share of earnings
before interest, taxes, depreciation and amortization
(EBITDA) in commercial accounting.
Raising the ETR will change the extent of the eco-
nomic benefits that accrue to the host country from a
given mining project. It will also shift the time profile
of those benefits. In the short run an increase in the
ETR will almost always raise the total tax revenue
received by the government. Over the longer run,
however, the increase is likely to discourage minerals
exploration and mining development. Tax revenues
are likely to fall compared to what would have hap-
pened otherwise. Beyond some point, the long-run
revenue loss will outweigh the short run gain from the
increase in the ETR.

Mining Report on Mongolia — Averting the Resource Curse • 9

 The shape of the tax revenue profile over time will, to
a significant degree, depend upon the ETR that is
levied on mining operations in other countries.
Footloose international mining investment will tend
to avoid the higher taxing jurisdictions in favor of the
lower taxing ones.
Other things being equal, the most successful coun-
tries will tend to be those with the lowest ETRs. They
will also be characterized by even-handed taxation
treatment of informal or artisanal mining compared
to commercial mining operations.
3.1.2 Composition of Mining Taxation
Governments around the world impose a wide range
of taxes, fees and charges on the mining activities that
are conducted within their jurisdiction. Most of these
are also imposed on other business activities, such as
corporate income tax, value-added tax, or sales tax.
Others, however, may be specific to mining, such as
mining royalties.
Each tax can have quite different implications for eco-
nomic efficiency, revenue yield, the division of risks
between the public and private sectors, the costs of
public administration and compliance, and trans-
parency. Moreover, these implications may need to be
assessed comprehensively due to the interactions
between different taxes. This is certainly the case for
the overall tax burden.
Other things being equal, economic efficiency generally
prefers taxes to be levied on a base that is as broad as
possible and is least likely to change economic behav-
ior, and at a rate that is as low as possible. Doing so
helps to minimize losses in economic efficiency.
The shape of the tax revenue profile over time will,
to a significant degree, depend upon the ETR that
is levied on mining operations in other countries.
5 The Government of Papua New Guinea (PNG) introduced a tax on the economic rent that it expected to be generated by the Panguna
copper mine on Bougainville after the mine commenced operations in 1969. While operational, the mine made major contributions to
the country’s GDP, exports and public revenues. Civil insurrection on Bougainville closed the mine in 1989. Although a political settle-
ment to the conflict was reached in 2001, the mine owner and operator, Bougainville Cooper Limited, has been unable to access the
mine site, even though it has expressed interest in re-commissioning the mine. The PNG Government abolished the tax in 2003.
10 • Mining Report on Mongolia — Averting the Resource Curse
On this basis, product taxes are generally preferred to
input taxes and comprehensive tax regimes are gener-
ally preferred to selective ones. For this reason, econ-
omists are generally lukewarm about any regime of
product-specific taxes, such as mining royalties, in
contrast to the more broadly-based regimes such as a
single rate of tax on all corporate profits or a single
rate of value-added tax on all goods and services.
One of the arguments advanced to justify specific
mining taxation is based on the twin facts that most
mineral resources are publicly owned and that their
successful exploitation can generate substantial eco-
nomic rents. The argument is that specific mining tax-
ation ensures that the resource owners will share in
these rents but it suffers from several significant
weaknesses:
• The corporate income tax will ensure that mining
rents are shared with the public.
• Most mining royalties do not tax the economic
rents from minerals development.
• The few countries that have attempted to do so
have not been successful in attracting subsequent
investment into their mining sector.5
• Most mining royalties are a tax on mining output.
They reduce mineral exploration and exploitation
compared to what would otherwise occur.
• Economic rents are generated by other natural
resources, such as agricultural land, forestry and
fisheries, but they are generally not subjected to
royalties.
• Economic rents are purposefully generated by pub-
lic policy, such as intellectual property law, but they
are never subjected to specific taxation measures.
The different taxes have different implications for risk
sharing between the private and the public sectors.
This is highly significant given the substantial risks
associated with mining exploration and development.
A single rate of tax on corporate profits will share these
risks more or less evenly. In contrast, a royalty, which is
based on either volume or value, will tend to shift more
of the risk onto the mining company and less onto the
government, as mining royalties are generally payable
even if the mine is not making profits. Conversely a pro-
gressive income tax will shift more of the risks onto the
government, other things being equal.
Although a mining company may be in a better position
to assume more of the risk than the government, partic-
ularly one in a developing or transition country, doing
so always involves a cost. Accordingly, the government
will need to compensate the mining company for
assuming this additional risk by imposing a lower rate
of tax rate than would otherwise have been the case.
Similar considerations apply to the revenue yield that
may be expected from the different taxes on mining.
Generally speaking, the greater the risks that are
imposed on the mining company by the tax legisla-
tion, the lower the revenue yield to the government.
This conclusion, of course, depends on other things
being equal.
There are pronounced differences between the
administrative and compliance costs of the various
tax instruments applied to mining. Some taxes are rel-
atively easy for the public sector to administer and for
mining companies to demonstrate their compliance.
This keeps the costs down for both parties and mini-
mizes the opportunities for corruption. Both repre-
sent significant advantages in the context of a devel-
oping or transition economy. Many types of mining
royalty fall into this category.
In contrast, corporate income taxes are much harder
to administer, particularly for developing and transi-
tion countries. They often lack the relatively sophisti-
cated institutional capacity that is required to admin-
ister income taxes in very complex and highly capital
intensive sectors, such as mining. Such contexts are
also much more susceptible to tax avoidance and eva-
sion, as well as corruption.
Overall then, the case for mining royalties is relatively
weak from the perspectives of economic efficiency, risk
sharing and revenue yield compared to the corporate
income tax. On the other hand, the case is on much
firmer ground when it comes to the costs of tax admin-
istration and compliance. This advantage is, however,
6 Otto et al 2006
7 Otto et al 2006
8 Otto et al 2006
Although a mining company may be in a better
position to assume more of the risk than the gov-
ernment, particularly one in a developing or transi-
tion country, doing so always involves a cost.
more or less neutralized where a country already has a
corporate tax regime in place. Nevertheless, most
countries have both — a general regime to tax corpo-
rate income and a specific regime to impose royalties
on the mining of selected minerals.6 The major excep-
tions are some provinces in Argentina, Chile, some
Canadian provinces, Mexico, South Africa, Zimbabwe,
and some States of the U.S. Of these, Chile, South
Africa, and Zimbabwe are each actively considering
the introduction of a royalty on mining.7 China intro-
duced a royalty tax in 2007.
Research shows that not having a mining royalty does
not necessarily guarantee a low ETR overall.8 On the
one hand, Mexico and Greenland have high ETRs but
do not levy mining royalties. On the other hand,
Western Australia, which does levy a royalty, has a
lower ETR than Chile, which does not. In Chile, how-
ever, the absence of the royalty means that a mine
would earn a higher internal rate of return for the
owners than what it would have earned had it been
located in Western Australia, other things being
equal. This is because royalties are payable in Western
Australia over the early years of a mine’s operation
before it becomes profitable and therefore before it
would be liable to income tax in Chile.
Regulation of Mining
The commercial viability of a mining project is
dependent upon the regulatory burden that is imposed
on it by the host government. Since 1990 there has
been an emerging recognition that there is a trade-off
between the regulatory and tax obligations, which can
be imposed on a mining project, if it is to be interna-
tionally competitive and to be capable of attracting
direct foreign investment, technology and know how.
Mining Report on Mongolia — Averting the Resource Curse • 11
Because mines are often located in remote regions
or regions with low population densities, there may
be little or no political incentive for the central, or
even provincial, governments to provide public
funds for this purpose.
In parallel, there has been increased pressure to
address the social and environmental impacts of min-
ing projects. Local communities who stand to be affect-
ed by such projects have demanded a greater say in the
terms on which they may proceed and a greater share in
the revenues that they are expected to generate.
As a consequence of these pressures, jurisdictions
around the world have had to revise their policy
approach to mining. This has lead to a wide range of
legal and institutional changes. A series of public pol-
icy principles and practices have emerged from this
legal and institutional evolution, which are now rec-
ognized as representing international best practice for
mining regulation. According to the World Bank, the
international consensus is that modern mining regu-
lation should adhere to the principles of:
• transparency and fairness;
• clarity;
• non-discretionary license administration;
• conclusive decision-making within specified time
frames;
• non-discrimination;
• uniform standards and administrative proce-
dures;
• a lead agency being the coordinating authority
within government; and
• coordination with other regulatory agencies.9
Provision of Infrastructure Services
A mining prospect’s proximity to roads, railways and
power has a major impact on the capital costs of its
development. Many countries leave the provision of
infrastructure to the relevant mining companies or
9 The World Bank 2004
12 • Mining Report on Mongolia — Averting the Resource Curse
require them to provide what the countries specify.
For example, it is not uncommon for a mine to provide
local communities, which would be affected by a min-
ing project, support for expanding their transportation,
educational, medical and sporting facilities. Because
mines are often located in remote regions or regions
with low population densities, there may be little or no
political incentive for the central, or even provincial,
governments to provide public funds for this purpose.
Geological prospects that would normally be com-
mercially viable become uneconomic if the costs of
providing the necessary infrastructure are too high.
Governments, therefore, need to give serious consid-
eration to developing infrastructure in such areas, as
its availability can have a major impact on subsequent
economic development.
3.4 Macroeconomic Stability
One of the outcomes of the ‘resource curse’ debate is
the realization that mineral projects can foster overall
economic development or hinder it. The difference
depends on how the windfall in public revenue, which
mining usually generates, is applied. That windfall
can flow from an increase in metal prices and/or min-
ing production
A sustained increase in mineral output can also affect
the international competitiveness of other sectors of
the economy, notably manufacturing. The expansion
puts upwards pressure on the exchange rate of the
host country against all other currencies. This tends
to lower export prices in the local currency and raise
import prices in that currency. As a consequence the
mining expansion will tend to ‘crowd out’ other export
industries. The phenomenon is popularly known as
the ‘resource curse’ or the ‘Dutch Disease’.
The main thrust of macroeconomic management
should be to prevent a spending spree by the public
sector in response to a significant expansion of mining
revenues. Allowing the public and financial sectors to
invest in foreign financial assets can help to sterilize
the windfall in public revenue and offset an economy’s
absorptive constraints.
3.5 Distributing the Benefits
Much of the debate over the role of mining to eco-
nomic development tends to focus on the division
between the mining companies and the host govern-
ments of the economic surplus generated by mining
projects. The more important question is how to dis-
tribute the potential public revenue windfall from
mining within the host country.
This can be done by either ‘fiscal decentralization’ or
‘revenue sharing’. Fiscal decentralization is the
process by which some taxation powers are given to
provincial or local government, either by the constitu-
tion or by delegation from the central government. In
contrast, under revenue sharing, the central govern-
ment collects the taxes but simply distributes a por-
tion of the revenue to the lower levels of government.
All countries practice some degree of fiscal decentral-
ization or revenue sharing in relation to mining proj-
ects.10 This is thought to reflect the fact that a mining
project:
• can have a more concentrated environmental
impact than other industries;
• may result in the local economy undergoing pro-
nounced ‘boom-bust’ cycles; and
• may lead to significant changes in the social fabric
11
of the local area.
For example, the immigration of mine workers may
sharply add to the burden on the social and economic
infrastructure in the area. It may also be accompanied
by increased prostitution, drug use and alcohol abuse.
All of these impacts will require additional expendi-
tures by local and/or provincial governments.
Without adequate taxing powers, lower levels of gov-
ernment are dependent on the central government’s
budget processes to allocate revenue to it to meet such
expenditure demands.
Local communities affected by mining operations
need to see that they benefit directly from those oper-
ations. Failure to do so can result in conflict, which
can affect the viability of the mining project. This was
10 James Otto, 2001, ‘Fiscal Decentralisation and Mining Taxation’, Mimeo, Report prepared for The World Bank Mining Development
Group, The World Bank, March.
11 Otto 2001
the case with the Panguna copper mine in the
Bougainville province of Papua New Guinea. A pre-
ferred way to avert this threat is to have at least a por-
tion of mineral royalties paid directly to local govern-
ments or local land holders, as is now done in Papua
New Guinea.
That said, not all those who are affected by a mining
project will benefit from spending by the relevant
local government. Taxation mechanisms are one way
of recognizing the unique impacts that mines can
have on a locality — for example, by allowing the min-
ing company in question a tax deduction or tax credit
for investing in community infrastructure. Of course,
doing so then raises questions about what and who
determines whether a specific expenditure is an
allowable deduction or credit, and what limits, if any,
should apply. Another way is to ensure that those who
are affected share in the royalties that are paid by
mining companies.
As a consequence the mining expansion will tend
to ‘crowd out’ other export industries. The phe-
nomenon is popularly known as the ‘resource
curse’ or the ‘Dutch Disease’.
As we saw earlier, most jurisdictions extend special
taxation treatment to mining. This fiscal discrimina-
tion may be justified by the need to pay compensation
to the mineral owners or local land holders, and the
fact that mining is a risky and capital intensive busi-
ness. It may also be necessary to influence taxpayer
behavior.
3.8 Addressing Sovereign Risk
Due to the substantial amounts of capital that are typ-
ically involved, companies looking to invest in a min-
eral project are particularly sensitive to the risks
involved and put considerable effort into trying to
identify, measure, diversify and control those risks.
Mining Report on Mongolia — Averting the Resource Curse • 13
Stability agreements have been used to place strict
limits on the fiscal and regulatory obligations
imposed by government on a mining project for a
fixed period of time. Unfortunately, the enforcement
of such agreements can rarely, if ever, be formally
guaranteed.
Once the capital has been invested, the nature of min-
ing assets means that the residual value at any given
time cannot be withdrawn from the country or readi-
ly liquidated.
One of these is the risk that the host government will
unilaterally change the ‘rules of the game’ during the
life of the project. This is termed sovereign risk. It
principally applies to changes to the taxation and reg-
ulatory regimes that can affect the financial returns
from the project to its sponsors and investors. In those
cases where the host government is financially or
operationally involved in the project in some way,
such as by providing equity, debt, or infrastructure
services, the term also applies to the risk of the gov-
ernment not honoring its contractual obligations.
Sovereign risk is generally driven by rent-seeking in
the host countries, which can take the form of trans-
parent advocacy within the rule of law, or corruption.
Minimizing sovereign risk is clearly in the interests of
the host country, even if it is not necessarily in the
interests of those who make up its government. The
lower the sovereign risk, the more investment a host
country will be able to attract, other things being
equal, across the board. This is particularly important
for developing countries as they have an acute need
14 • Mining Report on Mongolia — Averting the Resource Curse
for the jobs, technology and know-how that inwards
foreign investment generally brings with it. Less
investment also means a smaller public revenue
stream from the country’s taxation system.
Stability agreements have been used to place strict
limits on the fiscal and regulatory obligations
imposed by government on a mining project for a
fixed period of time. Unfortunately, the enforcement
of such agreements can rarely, if ever, be formally
guaranteed. In the absence of specific constitutional
limitations, governments typically cannot bind their
successors so any such guarantee essentially rests on
political convention and moral suasion.
A stability agreement is essentially a way for a host
government to express their country’s commitment to
the project in question. By making that commitment
more explicit and more transparent, such agreements
have the advantage of being able to increase the sub-
sequent costs to the host country of any abrogation of
an agreement by a subsequent government. This is
likely to reduce a government’s preparedness to break
the agreement but it may not enough to avert every
opportunity to do so.
Stability agreements can, however, be counterproduc-
tive if they are not handled in a transparent and con-
sistent manner, and in accordance with clear guide-
lines laid down beforehand. Governments also need
to consider measures that would complement and
reinforce stability agreements, such as by:
• enhancing the institutions that may be involved in
conflict management within the host country;
• improving the transparency and accountability of
public management of mining revenues, and
• implementing measures to limit the scope for
rent-seeking behavior and corruption.
4. Lessons from International Experience
This chapter will canvass the more recent experience of
countries in applying the policy principles, which were
outlined in the previous chapter, to the development of
the taxation, regulatory and institutional framework
under which their mining sector is expected to operate.
In canvassing the international experience in applying
these policy principles, the assessment will be conduct-
ed in two distinct but complementary parts.
The first part will be a high level and broadly based
assessment of the essential differences in the practical
application of these policy principles across countries.
The focus will be on the overall consequences of the
policy framework in each country for its international
competitiveness in attracting mining investment, par-
ticularly in minerals exploration.
By its very nature, investment in minerals exploration
is much more sensitive to changes in the policy frame-
work than mines that are already operational. In the
case of mineral exploration, most of the investment
has yet to come and the risks are generally very high.
In the case of operational mines, most of the invest-
ment has been sunk and is therefore of little relevance
to decisions about the future. Moreover, the risks are
generally lower. It is for these reasons investment in
exploration is both a much better indicator, as well as
a ‘leading’ indicator, of the economic wisdom of such
policy changes for the country that implements them.
The other part of the approach will consist of a series
of case studies. These will explore the experience of
selected mineral rich developing countries in greater
depth, as their experience is of the most direct rele-
vance to Mongolia. The selection has sought to iden-
tify a series of countries which have had quite differ-
ent experiences in applying the policy principles
enunciated earlier.
One case study involves a country which has been
internationally competitive in attracting mining
investment for a number of decades (Chile). The sec-
12 The latest survey is published in The Fraser Institute, 2008, The Fraser Institute Annual Survey of mining Companies 2007-08, The
Fraser Institute, Vancouver, BC
13 The countries covered by the survey are: Botswana, Burkina Faso, the Democratic Republic of the Congo, Ghana, Mali, Namibia, South
Africa, Tanzania, Zambia and Zimbabwe (Africa); China, India, Indonesia, Kazakhstan, Mongolia, and Turkey (Asia); Australia, New
Zealand and Papua New Guinea (Australasia); Finland, Ireland, Russia, Spain and Sweden (Europe); Canada, Honduras, Mexico,
Panama, and the US (North America); Argentina, Bolivia, Brazil, Chile, Columbia, Ecuador, Peru and Venezuela (South America).
ond case study captures the experience of a country
that has recently undertaken fundamental and com-
prehensive policy reform and is now regarded as
among the best of places in which to invest in mining
(Botswana). The third case study is about a country
that has had a number of unsuccessful attempts at
policy reform but is now making real progress
towards that goal (Papua New Guinea).
On the basis of these reviews, the chapter will conclude
with a distillation of international best practice in terms
of the preferred policy measures and settings that may
be expected to facilitate a country’s international com-
petitiveness in attracting mining investment.
4.1 International Experience in Cross Section
Since 1997, the Fraser Institute of Canada has conduct-
ed an annual survey of mining and exploration compa-
nies to assess how mineral endowments and public
policy factors, such as the taxation and regulation
regimes, affect investment in minerals exploration.12
The survey results reflect the opinions of executives
and exploration managers in mining and mining con-
sulting companies operating in 68 mining jurisdic-
tions spread over six continents, including sub-
national jurisdictions in Canada, Australia, and the
United States.13 Both large and small companies are
covered by the survey.
While geological prospects and economic outlook
clearly influence the extent of investment in minerals
exploration in a jurisdiction, the public policy, regula-
tory and institutional framework that exists there is a
By its very nature, investment in minerals explo-
ration is much more sensitive to changes in the
policy framework than mines that are already
operational.
Mining Report on Mongolia — Averting the Resource Curse • 15
 critical determinant of the observed investment out-
comes. In the decade of the survey’s existence, the
quality of this framework has taken on increasing
importance in a jurisdiction’s ability to attract inter-
national mining investment.
The Policy Potential Index (PPI) is a composite
index. It measures how attractive the policy, regula-
tory and institutional framework in a mining juris-
diction is from the perspective of a mining investor.
The respondents to the survey were asked to assess
the impact of a series of public policy, regulatory and
institutional factors on a five point scale, which ranges
from ‘encourages investment’ to ‘would not invest due
to this factor’.14 The factors explicitly nominated for
assessment are:
• the uncertainty concerning the administration,
interpretation, and enforcement of existing regu-
lations;
• environmental regulation;
• regulatory duplication and inconsistencies
(includes inter- and intra-governmental overlaps);
• the mining taxation regime (includes personal,
corporate, payroll, capital and other taxes, as well
as the complexity of taxation compliance);
• uncertainty concerning native land claims and
protected areas;
• the quality of the infrastructure (includes access
to roads and power);
• socio-economic agreements and community
development conditions (includes local purchas-
ing and processing requirements and require-
ments to supply social infrastructure such as
schools or hospitals, etc.);
• political stability;
• labor market regulation;
• the quality of the geological database (includes
quality and extent of the information and ease of
access to it); and
14 The other assessment categories were: ‘not a deterrent to investment’; ‘a mild deterrent to investment’; and ‘a strong deterrent to investment’.
15 For each factor, a jurisdiction’s rank is based on the percentage of respondents who judged that it ‘encourages investment’. The jurisdic-
tion with the highest percentage of such responses is ranked first on that factor and the jurisdiction with the lowest percentage is ranked
last. The ranking of each jurisdiction across all the factors is averaged and indexed to a base of 100. A jurisdiction that is ranked first in
every category would score 100; one that is ranked last in every category would score 0.
16 • Mining Report on Mongolia — Averting the Resource Curse
• security situation (includes physical security from
threat of attack by terrorists, criminals, guerrilla
groups, etc).
The Fraser Institute has developed the following
indexes to present the different perspectives that may
be gleaned from the responses to its surveys:
• Policy Potential Index (PPI);
• Current Mineral Potential Index (CMPI);
• Best Practices Mineral Potential Index (BPMPI);
and
• Room for Improvement Index (RII)
A brief discussion of the survey results for each index
for 2007-08 follows. In doing so, the discussion high-
lights the best and worst in class.
4.1.1 Policy Potential Index
The Policy Potential Index (PPI) is a composite index.
It measures how attractive the policy, regulatory and
institutional framework in a mining jurisdiction is
from the perspective of a mining investor. It is based
on country rankings on each of the above assessment
factors that have been indexed to a base of 100.15
In the 2007-08 Survey the highest score on the PPI
went to Quebec with an index of 97.0. The other top
ten jurisdictions on the PPI were Nevada, Finland,
Alberta, Manitoba, Chile, Utah, Wyoming, Ireland,
and Sweden.
For the first time in the ten-year history of the survey,
a jurisdiction — Honduras — failed to achieve any
positive responses on any of the assessment factors
and scored 0 on the PPI. The other bottom ten juris-
dictions were Zimbabwe, Ecuador, Panama, Bolivia,
India, Indonesia, Mongolia, Philippines, and
Venezuela.
4.1.2 Current Mineral Potential Index
The Current Mineral Potential Index is based on
respondents’ answers to a survey question about
whether or not a jurisdiction’s mineral investment
potential under the current policy framework encour-
ages or discourages investment in mineral explo-
ration. Some jurisdictions with a high PPI but limited
hard mineral potential will receive a lower score on
the CMPI, while others with a low PPI but strong
mineral potential will do better. There is, however,
considerable overlap between the two indices.
In the 2007-08 survey, the top five jurisdictions on the
CMPI were Mexico, Quebec, Chile, Burkina Faso, and
South Australia. The bottom five jurisdictions were
Venezuela, Zimbabwe, Montana, Wisconsin and
Ecuador.
4.1.3 Best Practices Mineral Potential Index
The Best Practices Mineral Potential Index (BPMPI)
reflects respondents’ assessments of the mineral
investment potential of a jurisdiction were it to adopt
a ‘best practice’ policy framework. In other words, this
index represents a jurisdiction’s pure or highest possi-
ble mineral potential given the most comprehensive
and extensive set of taxation, regulatory and institu-
tional reform.
The differences between a jurisdiction’s score on the
BPMPI and those on the previous two indices are very
informative. In 2007-08 Indonesia ranked near the glob-
al bottom on the PPI but tied for top place on the BPMPI.
In 2007-08 the other top ranked jurisdictions were
Russia, Brazil, Ghana, the Philippines, Minnesota,
and Papua New Guinea. The least attractive jurisdic-
tions in this regard were Honduras, South Dakota,
New Zealand, California, and Washington State.
4.1.4 Room for Improvement Index
The Room for Improvement Index (RII) is perhaps
the most revealing of the four indices. It is the differ-
ence in mineral potential under a ‘best practice’
framework and that based on current practice. This is
a measure of the scope for a jurisdiction to increase its
international competitiveness in attracting mining
16 IMF [International Monetary Fund], 2007, Botswana: Selected Issues and Statistical Appendix , IMF Country Report 07/228,
International Monetary Fund, Washington, DC, July [accessed at www.imf.org/external/pubs/ft/scr/2007/cr07228.pdf ]
17 The World Bank 2004
investment by reforms to its policy, regulatory and
institutional framework.
The survey responses on Russia in 2007-08 illustrate
the measure. When asked about Russia’s mineral
potential under ‘current practices’, only 45 percent of
respondents assessed its potential as either ‘neutral’ or
‘encouraging’. In contrast all respondents assessed
Russia’s mineral potential as being either ‘neutral’ or
‘encouraging’ were it to adopt a best practices taxa-
tion, regulatory and institutional framework. Thus
Russia scored 55 percent on the RII.
In 2007-08 the jurisdictions with the greatest room
for improvement were Montana, Venezuela,
Wisconsin, Ecuador, and Minnesota. The jurisdic-
tions with the least were Ireland, Chile, Alberta,
Namibia, and Burkina Faso.
4.2 Case Study: Botswana
The economy of Botswana is dominated by the min-
ing sector, which is in turn dominated by diamonds.
Over the past 10 years, the mining sector has con-
tributed an average of 35 percent of the country’s
GDP, with diamonds constituting nearly 94 percent of
all mineral exports.16
Botswana is the world’s largest diamond producer,
measured by both carats and value. Its diamond boom
began in 1965 and followed the discovery and devel-
opment of large amounts of high quality diamonds.
Between 1966 and 1989 its GDP grew at over 8 per-
17
cent a year, which was the fastest growth at that time.
A large part of the windfall was put in foreign savings
and only used when the absorptive capacity of the
economy was thought to be sufficient. Fiscal and
monetary policy was disciplined.
The government’s successful partnership with De
Beers, the world’s largest diamond mining company,
has helped develop the country’s mining sector.
Botswana’s diamond deposits are in kimberlite pipes,
which concentrate the gemstones. This makes large-
scale low cost production possible, which in turn con-
Mining Report on Mongolia — Averting the Resource Curse • 17
 Policy Settings for Mining Taxation Regime, Botswana
Table 2
Taxation Provision
Corporate income tax rate
Withholding tax rate on dividends
Mining royalty
Import duty on mining plant & equipment
Export duty on mineral commodities
Value-added tax
Depreciation of mining plant & equipment
Carry forward of losses
Source: Botswana Department of Mines 2006
tributes to high levels of public revenue through cor-
porate taxes, royalties, and dividends from the gov-
ernment’s 50 percent share in Debswana, its joint
venture with De Beers to mine diamonds in
Botswana, as well as the government’s 15 percent
stake in De Beers itself.18
In July 1999 Botswana’s Parliament passed a com-
pletely new Mines and Minerals Act. The policy objec-
tive was to make the legislation ‘investor friendly’ and
to deal with the criticisms of property tenure and
ministerial discretion under the previous mining law.
The new act does not apply to petroleum which is reg-
ulated by the Petroleum (Exploration and
Production) Act, nor does it regulate the mining of
diamonds which will continue to be determined by
negotiated agreement with the government.
The Mines and Minerals Act provides for:
• The retention of rights over a mineral deposit
where it cannot be exploited immediately.
Retention licenses may be granted initially for
three years and renewed once for up to three
years. This contrasts with the previous ‘use it or
lose it” policy, which allowed a license to be termi-
nated if work was stopped.
• The prospecting license covers up to 1,000 km2 is
initially for up to three years and is renewable for
18 Botswana Department of Mines, 2006, Mining Investment Opportunities in Botswana, Republic of Botswana, Gaborone, 24 February
[accessed at www.gov.bw/docs/ ]
19 Botswana Department of Mines 2006
18 • Mining Report on Mongolia — Averting the Resource Curse
Policy Setting
Variable rate, from 25% (rate for the non-mining sectors) up to 55%
15%
10% (precious stones)
5% (precious metals)
3% (other minerals)
None
10%, refundable on exports
Immediate 100% write off
Unlimited
two periods of two years each. Mining licenses are
issued for up to 25 years, renewable for periods of
25 years at a time.
• The abolition of the government’s previous right
to free equity participation. It can now acquire up
to 15 percent of a new mining venture on com-
mercial terms.
• Restrictions on the transfer of mineral conces-
sions were liberalized explicit environmental pro-
tection measures incorporated into the act.
• A reduction in mining royalties for all minerals,
except precious stones and precious metals.
• The granting, renewal and transfer of licenses was
made more automatic and predictable with little
or no scope for Ministerial discretion.
• A new mining taxation system was introduced.
Companies that already operating mines have a
‘once only’ option to continue under existing tax
agreement.19
Highlights of the new mining tax regime are in Table
2. The general corporate income tax regime applies to
mining but the latter is subject to a variable tax rate.
The tax rate cannot be less than the standard corpo-
rate tax rate (25 percent). The variable rate formula
only kicks in only when taxable income as a percent-
age of gross revenue — the profitability ratio — is
more than 33.3 percent. The tax rate then rises with
the profitability ratio to a theoretical maximum of
55 percent when taxable income equals gross income.
Under the previous mining tax regime, companies
could only write off their capital expenditure against
taxable income over the lesser of ten years or the
remainder of the life of the mine. Given the more
favorable treatment of depreciation and the unlimited
ability to carry forward loses under the new taxation
regime, it is unlikely that any significant tax will be
paid until the mining company has recovered all of its
investment in a mine.
As a consequence of the above policy reforms,
Botswana broke several records on the Fraser
Institute Survey for 2007-08.20 Botswana’s score for
investment attractiveness score on the PPI was the
highest ever for an African country in the ten-year
history of the survey. It was ranked at 11th place (out
of 68) in terms of investment attractiveness in 2007-
08 and missed out from being placed among the top
ten countries by the smallest of margins.
Of perhaps even greater significance is the fact that
Botswana has had the greatest increase in its invest-
ment attractiveness score on the PPI out of all the
countries surveyed by the Institute over the past four
years. In this period it also experienced the greatest
improvement in its investment attractiveness ranking,
rising from 50th place in 2004-05 to 11th in 2007-08.
4.3 Case Study: Chile
Foreign mining companies created the Chilean cop-
per industry in the 20th Century.21 By the 1960s two
US mining companies — Anaconda and Kennecott —
owned the four mines that accounted for most of the
country’s copper output. Successive Chilean
Governments progressively increased their control
over and equity interest in these mines. The Allende
Government finished the process by nationalizing
them within Codelco, a company owned by the
Chilean government.
Following his overthrow of the Allende Government in
1973, the Pinochet regime rejected socialism and
20 Fraser Institute 2008
21 The following history is based on The World Bank 2006
22 The Fraser Institute 2008
23 Otto et al 2000
The Real Climate Threat to Developing Countries — Early, Deep Cuts in Emissions • 19
embraced more market-oriented economic policies.
The government liberalized foreign investment to
attract private investment. Although Codelco contin-
ued to operate the former Anaconda and Kennecott
mines, direct foreign investment, played an increasing
role in the development of the Chilean copper industry.
In 1978, Exxon bought the Disputada Company from
the Empresa Nacional de Mineria (ENAMI), another
state-owned company with mining assets. Subsequently,
private mining companies developed a series of new
large-scale mines in Chile, including Escondida the
world’s largest copper mine. As a consequence, copper
production in Chile rose rapidly and Codelco’s share
more than halved. For nearly two decades, Chile has
enjoyed rapid economic growth, in large part due to the
massive expansion of its copper industry.
Of perhaps even greater significance is the fact
that Botswana has had the greatest increase in its
investment attractiveness score on the PPI out of
all the countries surveyed by the Institute over the
past four years.
For over two decades Chile has offered private
investors a very favorable investment climate in the
mining sector. The Fraser Institute Mining Survey has
consistently put Chile at the top of its rankings of
overall investment attractiveness — in 2007-08 it was
in 6th place.22 In large part this attractiveness rests on
Chile’s very favorable mineral taxation regime, partic-
ularly its general corporate tax regime — see Table 3
for the details of its key policy parameters.
Extensive research has shown that the effective tax
rate of the Chilean taxation regime has consistently
been among the lowest of the world’s mining jurisdic-
tions.23 Perhaps most telling of all is that, of all the
copper mines that have been opened around the
 Policy Settings for Mining Taxation Regime, Chile
Table 3
Taxation Provision
Corporate income tax rate
Withholding tax rate on dividends
Withholding tax rate on interest payments
Withholding tax rate on foreign services
Mining royalty
Import duty on mining plant & equipment
Export duty on mineral commodities
Value-added tax
Depreciation of mining plant & equipment
Tax holiday
Ring fencing of tax liability of nominated
activities from the rest
Source: James Otto, John Cordes, and Maria Batarseh, 2000, Global Mining Taxation Comparative Study, 2nd edition, Institute for Global Resources Policy and
Management, Colorado School of Mines, Golden CO
world in the past two decades, the bulk of the new
productive capacity has been in Chile.
As Chile does not levy royalties on minerals produc-
tion, one might conclude the best policy is to eschew
royalties all together. This misses the point, which is
that the overall burden of regulation and taxation on
the mining sector is the most important factor in
being internationally competitive in attracting mining
investment. The composition of any given burden is
generally of secondary importance.
4.3 Case Study: Papua New Guinea
In terms of its mineral development potential, Papua
New Guinea ranked near the top of the Fraser
Institute’s global rankings in 2007-08 (based on its
Current Mineral Potential Index).24 In sharp contrast,
however, it only ranked 55th (out of 68) on the
Institute’s measure of the investment attractiveness of
Papua New Guinea’s current policy framework.
The evolution of the Papua New Guinea taxation and
regulatory and tax regimes for the mining sector
explain, at least in part, the country’s poor showing in
24 The Fraser Institute 2008
25 The Additional Profits Tax was a form of resource rent tax. It was levied on the profits that are earned above a threshold internal rate of
return. Footnote 5 has more background on the PNG experience with it.
20 • Mining Report on Mongolia — Averting the Resource Curse
Policy Setting
15% (two elective regimes are available)
35%
4% (payments to foreign bank)
35% (otherwise)
20% (for technical services)
None
10%
None
Refundable on exports
Accelerated depreciation
None
None
terms of investment attractiveness. Table 4 has the
key taxation parameters that applied in Papua New
Guinea in January 2008.
Between 1996 and 2000 the Papua New Guinea gov-
ernment raised the rate of its mining royalty from
1.25 percent to 2 percent and introduced a 4 percent
levy on assessable mining income, which was, in
effect, a supplementary royalty.
These mining-specific taxes were in addition to those
imposed by the corporate income tax regime, which
includes withholding taxes on dividends, interest pay-
ments and off-shore services. They were also on top of the
Additional Profits Tax (APT) levied on resource projects25
and the significant restrictions on the tax deductibility of
exploration expenditures, which are part and parcel of
the treatment of mining by the corporate tax regime.
During this period, the government enacted legisla-
tion to give it the right to acquire up to 30 percent of
the equity in a mining lease when the lease is issued.
The acquisition price to the paid by the government is
based on the exploration costs involved and not on the
full market value of a lease.
 Policy Settings for Mining Taxation Regime, PNG as of January 2008
Table 4
Taxation Provision
Corporate income tax rate
Withholding tax rate on dividends
Withholding tax rate on interest payments
Withholding tax rate on foreign services
Mining royalty (to be paid to provincial
governments & landowners)
Import duty on mining plant & equipment
Export duty on mineral commodities
Value-added tax
Depreciation of mining plant & equipment
Tax holiday
Ring fencing of tax liability of nominated
activities from the rest
Exploration expenses
Infrastructure expenses
Notes: (a) excludes both interest receipts and payments
Source: IMF 2008
These tax and regulatory changes were implemented
by the Papua New Guinea government in an environ-
ment of depressed metals prices, widespread concerns
over sovereign risk and a deteriorating political situa-
tion within the country. By 2000 it was clear that
Papua New Guinea was uncompetitive in attracting
mining investment. Although global minerals explo-
ration declined between 1996 and 2000 due to
depressed metals prices, exploration in Papua New
Guinea contracted even more. As a consequence, the
country’s share of global exploration investment fell
significantly.
As a consequence of the country’s loss of global explo-
ration investment, the Papua New Guinea government
initiated a review of its fiscal regimes for minerals and
petroleum, which proposed a number of policy
26 The phasing-out of the levy was expected to be completed by the end of 2007 (see IMF [International Monetary Fund], 2008, Papua
New Guinea: Selected Issues and Statistical Appendix , IMF Country Report No. 08/93, International Monetary Fund, Washington, DC,
March [accessed at www.imf.org/external/pubs/ft/scr/2008/cr0893.pdf ])
Policy Setting
30%
10%
15%
25%
2% of value of output
None
None
10%, refundable on exports
Straight line basis over 10 yrs (assets with a life > 10 yrs)
Residual balance basis over lesser of 4 yrs or rest of project life
(assets with a life ≤ 10 yrs)
None
Mines on Special Mining Leases are ring fenced
Amortized on residual balance basis over lesser of 4 yrs or
rest of project life
Expenses on multiple licenses may be pooled
Expenses may be carried forward for up to 20 years
Tax credit equal to lesser of 0.75 of expenses or the tax
payable for the year
changes. In response, Papua New Guinea scrapped
the mining levy for all new projects in 2000 and
announced it would phase it out on existing projects.26
It also cut the tax rate for the APT but simultaneous-
ly lowered the threshold internal rate of return, which
triggers the APT, from 20 percent to 15 percent.
The mining industry and international investors wel-
comed the elimination of the mining levy but not the
lowering of the APT threshold. The negative implica-
tions of the APT for mining investment have been a
consistent concern since its introduction. Despite the
scrapping of the mining levy, Papua New Guinea
remained internationally uncompetitive in attracting
mining investment and its share of global mineral
exploration did not recover.
Mining Report on Mongolia — Averting the Resource Curse • 21
 Table 5
Total Taxation Liability
Jurisdiction Internal Rate of Return (%) Effective Tax Rate (%) for a Model Copper
Mine, Lowest Quartile
Sweden 15.7 28.6 of Taxing Jurisdictions,
Western Australia 12.7 36.4 2004
Chile 15.0 36.6
Zimbabwe 13.5 39.8
Argentina 13.9 40.0
China 12.7 41.7

Source: Otto 2004

In 2002 the government conducted another review of
its mining taxation regime. This led to the complete
elimination of the APT in early 2003, as well as cuts
in the corporate income tax to 30 percent and the div-
idend withholding tax to 10 percent. The mining roy-
alty rate was fixed at 2 percent of net smelter returns
and the restrictions on deducting off-site exploration
expenditures were relaxed. The government also
undertook to reassess the option in its mining law to
acquire up to 30 percent of the equity in any new min-
ing project.
The evidence to date suggests these policy changes are
having a positive economic impact. Investment in
minerals exploration in Papua New Guinea has risen
to the point where the country’s share of global explo-
ration has begun to recover. Recent research has esti-
mated that that returns to mining investment in
Papua New Guinea have increased compared to other
mining jurisdictions.27 On the basis of the internal
rate of return to a representative copper mine, Papua
New Guinea was ranked 20th out of 24 mining juris-
dictions in 1999 compared to 4th in 2003.
is highlighted by the latest Fraser Institute rankings.
For example, as measured by the Institute’s Room to
Improve Index, Papua New Guinea ranked at 16th
(out of 68) in 2007-08. The negatives include the
severe uncertainties associated with the system of cus-
tomary land title in Papua New Guinea, the deteriora-
tion in security, and widespread corruption.
4.4 Summary of International Best Practice
A recent World Bank study28 has reported the results
of earlier research to estimate the overall effective tax
rate (ETR) that is imposed on the mining sector by
the policy regime that is applied to the sector by lead-
ing mining jurisdictions across six continents.29 These
ETRs were expressed as a percentage of the gross
return to the owners of the mine over the assumed life
of the project.30 The results for the quartile of jurisdic-
tions which had the lowest ETRs in 2004 are set out
in Table 5. The Table also contains estimates of the
corresponding internal rates of return to mine owners
after the payment of all government taxes, fees and
charges, as well as operating expenses.

Despite the significant progress that has been made The original research quoted by the World Bank mod-
since 2002, a number of policy factors continue to eled the financial impact on the profitability of a sim-
have a substantially negative impact of the mining ulated copper mine project of all major taxes, fees and
investment climate in Papua New Guinea, a fact that charges, including mining royalties, that were levied

27 James Otto, 2002, ‘Materials for a Workshop on the Provision of the Papua New Guinea Tax System as Compared to Mining Taxation
Systems of other Nations’, Report Prepared for the PNG Department of Mining and The World Bank, as quoted in Otto et al 2006.
28 James Otto, Craig Andrews, Fred Cawood, Michael Doggett, Peitro Guj, Frank Stermole, John Stermole, and John Tilton, 2006, Mining
Royalties: A Global Study of their Impact on Investors, Government, and Civil Society, The World Bank, Washington, DC
29 James Otto, 2004, ‘International Comparative Tax Regimes’, 50 Rocky Mountain Mineral Law Institute, 17:1-45 The 24 jurisdictions
that were analysed by were Argentina, Arizona (US), Bolivia, Chile, Côte d’Ivoire, Ghana, Indonesia, Kazakhstan, Mongolia, Ontario
(Canada), Papua New Guinea, Peru, the Philippines, Poland, South Africa, Sweden, Tanzania, Uzbekistan, Western Australia (Australia).
30 This approach is the cash-flow equivalent of the national accounting measurement of GOS and the commercial accounting measure-
ment of EBITDA.

22 • Mining Report on Mongolia — Averting the Resource Curse

 International Best Practice Policy Setting for Mining Taxation Regimes
Table 6
Taxation Provision
Corporate income tax rate
Withholding tax rate on dividends
Mining royalty rate (ad valorem basis)
Tax on windfall profits
Import duty on mining plant & equipment
Export duty on mineral commodities
Value-added tax
Depreciation of mining plant & equipment
Depletion allowances
Ring fencing of tax liability of nominated
activities from the rest
Treatment of mineral exploration expenses
Treatment of environmental expenses
Treatment of mine closure &
rehabilitation expenses
Tax holidays
Carry forward of tax losses
Source: World Bank 2008
at the time of that research (2004). Such financial
models are particularly useful for comparative taxa-
tion purposes as all they enable the non-taxation
parameters of the project, such as the mine capacity,
the technology it uses and the revenue it earns, to be
held constant.
This research shows that a low ETR does not guaran-
tee a thriving mining sector. Zimbabwe is a case in
point. Although it had the 4th lowest ETR out of the
24 jurisdictions that were examined, there are many
other factors that make Zimbabwe an unattractive
place in which to conduct business or invest, particu-
31 They include: declining gross domestic product, hyperinflation, political instability, official hostility to foreigners, and endemic corrup-
tion (Otto et al 2006).
32 The World Bank, 2008, Mongolia Quarterly, The World Bank, Washington, DC, 28 January.
Best Practice Policy Setting
25% to 30%
15%
2% to 4%
None
None
None
Refundable
Accelerated & pooled depreciation
None
None
Amortized over 5 years
Expensed
Tax deductible contributions into sinking fund
None
Unlimited or Available for up to 7 years
larly for foreign companies.31 Overall these results
suggest that an internationally competitive ETR was
around 35 percent in 2004. It is unlikely to have risen
since that time.
Recently, the World Bank benchmarked the settings
for the policy regime to be applied to minerals explo-
ration and mining around the world.32 The key policy
settings have been benchmarked against international
best practice and are set out in Table 6. The overall tax
burden that is implied by these best practice settings
are consistent with the estimated ETRs in the lowest
taxing mining jurisdictions that were reported above.
Mining Report on Mongolia — Averting the Resource Curse • 23
24 • Mining Report on Mongolia — Averting the Resource Curse
5. Implications for Mongolia
The synthesis of international best practices for the
mining sector, which was developed in the previous
chapter, will be used as the basis for an assessment of
the Mongolian government’s proposed approach
towards mining in general, specifically examining the
Oyu Tolgoi mining project.
The Oyu Tolgoi project represents the most signifi-
cant mineral discovery that has been made in
Mongolia since independence. It has the potential to
be the largest copper and gold mine in the world but
this would require investment exceeding US$7 billion
in its development over the life of the project. For this
reason alone, its economic significance for the
Mongolian nation is without precedence.
As background to this assessment, this chapter will
first canvas:
• the situation and outlook that confronts the
Mongolian mining sector and its contribution to
the Mongolian economy;
• the nature of the taxation, regulatory and institu-
tional framework that is currently directed at the
mining sector in Mongolia; and
• the modifications to the policy settings for that
framework, which the Mongolian government
proposes to apply to the project and the terms on
which those modifications are being put forward.
Against this background the chapter will conclude
with an assessment of how the current policy frame-
work and the modifications to its settings proposed by
the Mongolian government compare to international
best practice, and how Mongolia can best proceed.
5.1 Mining & the Mongolian Economy33
Mongolia is a large, landlocked country in Asia, bor-
dered by the People’s Republic of China and the
Russian Federation. It has a population of 2.5 mil-
lion, about half of whom live in Ulaanbaatar, the
national capital. The countryside consists of vast
tracts of desert, semi-desert and mountainous ter-
33 This section draws heavily on The World Bank 2004 and 2008, as well as The World Bank, 2007, Mongolia: Sources of Growth, Country
Economic Memorandum, Report No. 39009MN, The World Bank, Washington, DC, 26 July.
rain. Climatic conditions are severe — during the
short summer season average temperatures range
from -40º C to +40º C
Mongolia’s transition from a planned to a market
economy has proceeded quite well compared to other
economies in similar circumstances. The government
undertook fundamental reforms to liberalize prices
and establish market institutions. Unlike several
Eastern European countries, Mongolia’s transition
was relatively smooth from a macroeconomic per-
spective and largely free from widespread social or
political unrest.
The Mongolian economy is dominated by agriculture
and mining. Since 2001 GDP has been growing
strongly with annual growth rates of between 8 and 10
percent. By 2006 Mongolia’s GDP was more than
US$1,000 per capita. The strong GDP growth in
2007 of nearly 10 percent was largely driven by the
contributions of the agricultural and services sectors.
Although its direct contribution to GDP growth in
that year was relatively small, mining was an impor-
tant indirect contributor.
In 2005, the mining sector directly accounted for 18
percent of Mongolian GDP, 66 percent of its industri-
al output, almost 76 percent of its export earnings and
20 percent of its public revenue. By 2007 the sector
was generating nearly half of the public revenue col-
lected by the government.
As with many developing countries, mining in
Mongolia consists of two quite distinct sub-sectors.
Commercial mining employs over 14,500 people,
while informal or artisanal mining is thought to
employ more than twice that number.
The Mongolian economy is dominated by agriculture
and mining. Since 2001 GDP has been growing
strongly with annual growth rates of between
8 and 10 percent.
Mining Report on Mongolia — Averting the Resource Curse • 25
5.1.1 Commercial Mining
Mongolia’s geology is complex and its mineral poten-
tial vast. In 2002 the country had over 140 registered
mining operations and about 6,000 known mineral
showings or mineral deposits involving 80 different
minerals. The most economically significant of the
mineral deposits are base metals, gold and fluorite.
Historically, the mining sector’s output has been dom-
inated by copper and gold. Although gold production
increased on an average annual basis over the five
years to 2002, there was a decrease in production in
2001-02.
Erdenet is Mongolia’s largest mine and its only copper
mine. It is a joint venture by the Mongolian and
Russian Governments. Erdenet employs over 6,000
people, earns about half of the country’s foreign
exchange and generates almost 25 percent of its pub-
lic revenues. Its output of copper and molybdenum
has been declining for some time and is expected to
deteriorate even further as the head-grade of its ore
declines.
Gold is primarily produced in Mongolia from placer
mines.34 In 2002, there were 136registered gold mines
and they were operated by either Mongolian compa-
nies or Mongolian-Russian joint ventures. They are
relatively small-scale operations that are progressive-
ly depleting their mineral reserves. Without active
exploration for new deposits, the declining trend in
gold output is likely to continue.
The largest seven gold mines produced around half
the country’s output of gold in 2002. In general, the
larger operations use outdated, inefficient and costly
technologies. Gold production, however, should
increase with the development of the Boroo hard rock
mine.
Mongolia is the fourth largest producer of fluorite in
the world, behind China, Mexico and South Africa. Its
fluorite reserves are twice those of China, which is the
largest producer. Its six fluorite mines produce
0.5 million tons of ore and 180,000 tons of concen-
trate a year. Four of these are operated by
34 Placers are shallow alluvial concentrations of gold.
35 The World Bank, 2007, Mongolia: Sources of Growth, Country Economic Memorandum, Report No. 39009MN, The World Bank,
Washington, DC, 26 July
26 • Mining Report on Mongolia — Averting the Resource Curse
Mongolrostsvetmet and account for 92 percent of the
country’s output.
Mongolrostsvetmet is Mongolia’s second largest min-
ing company and has interests in coal, placer gold and
fluorspar mines. It was set up in 1974 under an inter-
governmental agreement between Mongolia and the
Russian Federation, and is jointly owned by the
Mongolian State Property Committee and
Zarubejtsetmet.
In addition to the mines listed above, Mongolia has 14
coal mines, a tungsten mine and a salt mine, as well as
a large number of small quarries. Their output is
insignificant in terms of gross industrial production.
Since 2001 there has been a rapid increase in explo-
ration. There are now nearly 2,600 exploration licens-
es covering 40 million hectares — 26 percent of
Mongolian territory — which represents a five-fold
increase in both the number of licenses and the area
under exploration.35 As a consequence mines are
being developed at Borro, Bumbat and Ovol Ovoot
(gold), Tumurtiin (zinc), as well as Oyu Tolgoi (gold,
copper and molybdenum). The government is also
looking to ‘kick-start’ developments at:
• Surven-Sukhail (copper and molybdenum);
• Tsunheeg (tungsten);
• Asgat (silver);
• Burenhaan (phosphate);
• Selenge (iron); and
• Mardai (uranium).
5.1.2 Artisanal Mining
Artisanal mining in Mongolia is not a traditional eco-
nomic activity, but primarily a response to job losses
and declining real incomes as a result of the econom-
ic restructuring of the 1990s. The growth of artisanal
mining and its sales on the informal market have
become economically and politically significant in
Mongolia.
Much artisanal mining has focused on the gold-bear-
ing tailings discarded by commercial placer mines.
While it has provided significant economic
opportunities for poor Mongolians during
difficult economic times, artisanal mining
occurs outside the normal legal and regula-
tory framework, degrades the environment
and exposes miners to hazardous work con-
ditions and toxic chemicals.
The surge in commercial development of Mongolia’s
extensive placer deposits in the early 1990s left large
amounts of waste material that provided a resource
base for those mining with simple, affordable tools.
Artisanal gold mining started as a seasonal activity
involving hundreds of people but has escalated into a
year-round livelihood for an estimated 30,000 peo-
ple. During the summer months the number of min-
ers has been estimated at up to 100,000.
While it has provided significant economic opportu-
nities for poor Mongolians during difficult economic
times, artisanal mining occurs outside the normal
legal and regulatory framework, degrades the envi-
ronment and exposes miners to hazardous work con-
ditions and toxic chemicals. As artisanal miners have
few legal rights to the minerals they mine, conflicts
have emerged between artisanal miners and licensed
mining companies.
In 2001, the Mongolian government attempted to
accommodate artisanal mining by enacting an interim
regulation of this informal activity. That proved ineffec-
tive and unworkable; it lapsed after one year and was
not renewed. The government is now in the process of
drafting a legal framework for artisanal mining.
36 This section draws heavily on The World Bank 2004, 2007 and 2008.
37 The World Bank 2008, p. 16 and 2007 p. 125
38 The World Bank 2007, p. 131
39 James Otto , 2007, ‘Competitive Position of Mongolia’s Mineral Sector Fiscal System: the Case of a Model Copper Mine’, mimeo, January
[accessed at http://21576430.domainhost.com/docs/Dr.%20James%20Otto%20—
%20Mongolia%20Competitive%20Tax%20Report%20%202007.pdf ]
5.2 Policy Framework for Mining in Mongolia36
During the 1990s, Mongolia introduced substantial
and far reaching reforms to the policy, regulatory and
institutional framework that applied to the mining
sector in Mongolia. It made further changes to these
regimes in 2006.
The World Bank has judged the original reforms
favorably in terms of international best practice.
Nevertheless, The Bank has concluded the most
recent changes represent backwards steps, principally
because of the following developments.
• Mongolia now has one of the world’s highest
effective tax rates (ETR) on mining. The World
Bank has put it at over 68 percent of the gross
return to its owners.37
• The more recent changes have increased the scope
by which the government can compulsorily
acquire direct equity participation in the
Mongolian mining sector.38
This section will first outline the nature and extent of
the principal taxes that are applied to mining in
Mongolia and how they have evolved over recent
years. It will conclude with a description of the paral-
lel evolution of the rest of the policy framework that
affects mining.
5.2.1 Taxation of Mining
Annex A set out details of the taxes, fees and charges
that the Mongolian government levies on minerals
exploration and mining in Mongolia, as well as how
they have evolved over recent years.
Of these taxes, fees and charges, the most recent
research39 indicates that the following are the more
significant in terms of their implications for invest-
ment in the Mongolian mining sector:
• windfall profits tax;
• mining royalties; and
Mining Report on Mongolia — Averting the Resource Curse • 27
 • withholding taxes on interest and dividend pay-
ments.
Of these taxes, the windfall profits tax from copper
and gold production is by far the most critical. The tax
was introduced in 2006 and is levied at a rate of 68
percent on the profits due to world price movements.
The tax cuts in when world prices exceed defined
thresholds — US$6,500 per ton of copper and US
$500 per ounce of gold.40 These thresholds are rela-
tively low compared to current world prices. For exam-
ple, the average world price of copper for the month of
February 2008 was US$7,886 per ton and the price of
gold for that month was US$924 per ounce.41
Very few countries levy such taxes on mining sector
profits, let alone imposing them on top of substantial
corporate income taxes and mining royalties. Papua
New Guinea is one of the few countries to have done
so. The government abolished its Additional Profits
Tax in 2003 after it had become abundantly clear that
the Tax was seriously harming mining investment in
Papua New Guinea.
Mongolia imposes mining royalties on the gross value
of mineral production on an ad valorem basis. The
royalty rate is 5 percent for all minerals except placer
gold, which is 7.5 percent. Such rates are well above
international best practice. Moreover, it is unclear
whether mining companies are allowed to deduct any
payments for Mongolian mining royalties from their
liability for Mongolian income tax.
Of these taxes, the windfall profits tax from copper
and gold production is by far the most critical. The
tax was introduced in 2006 and is levied at a rate
of 68 percent on the profits due to world price
movements.
40 ADB [Asian Development Bank], 2007, Asian Development Outlook 2006, Asian Development Bank, Manila The Philippines, p. 149
41 The February 2008 copper price was sourced from the London Metal Exchange [accessed at www.lme.co.uk/dataprices_historical.asp ]
and the equivalent gold price from the London Bullion Association [accessed at www.lbma.org.uk/2008monthlygold.htm ]
42 The World Bank, 2007, Table 6.8, p. 124
43 The World Bank 2004, p. 52.
28 • Mining Report on Mongolia — Averting the Resource Curse
Payments to non-residents are generally subject to a
withholding tax of 20 percent.42 The rate of withhold-
ing tax is reduced under double taxation treaties with
other countries. The rates levied in Mongolia are sub-
stantially in excess of international best practice.
The rates of corporate income tax that are applied to
mining companies are internationally competitive.
Mining investment is, however, quite sensitive to cer-
tain other provisions of the corporate income tax
regime, namely:
• the amortization of exploration and development
expenses;
• the depreciation of fixed assets;
• the provision to carry-forward tax losses to future
years; and
• the deductibility of infrastructure expenses.
In the case of Mongolia, the treatment of these issues
by the corporate income tax law has yet to be clarified.
The most important of them from the perspective of
investment attractiveness is the lack of any provision
to carry tax loses forward to future tax years so that
they can be offset against future taxable income.
5.2.2 Regulatory & Institutional Framework for Mining
Throughout the 1990s, the role of the Mongolian gov-
ernment in the mining sector evolved from that of an
owner/operator to one of a manager/regulator. The
Minerals Law of Mongolia reflects this evolution.
Although enacted in 1997, it only became effective in
2001 when the government removed the 10 percent
tax on mineral exports.
The World Bank has described the 1997 Minerals Law
as being designed to accommodate the country’s lim-
ited institutional capacity by providing the legislative
basis for a regulatory framework that was simple,
robust and modern in character.43 Unfortunately, the
regulations that were meant to clarify many of the key
provisions of the Minerals Law were never imple-
mented and the most recent amendments by
Parliament to the Minerals Law represent a back-
wards step in the reform of the policy framework that
applies to mining in Mongolia.
Sweeping amendments enacted to the
Minerals Law in 2006 have introduced fur-
ther and more serious weaknesses. The prin-
cipal ones are the introduction of the concept
of Strategic Mineral Deposits and providing
for the government to compulsorily obtain or
acquire equity in such Deposits.46
The 1997 Minerals Law established:
‘• one-stop’ and ‘first-come-first-served’ processes
for making of an application for a mineral license
(whether exploration or mining) and having a
license granted;
‘• security of tenure for mineral licensees;
‘• assignment and transfer of mineral licenses by
licensees; and
‘• rules for environmental protection and the obliga-
tions of licensees.
The Minerals Law is complemented by a transitional
law to convert and re-register mineral licenses that
had been issued prior to enactment. The transitional
law continues to allow the Mongolian government to
recoup public exploration expenditure on 188 mineral
licenses prior to enactment of the Minerals Law.
The Mongolian Ministry of Industry and Trade has
overall responsibility for minerals legislation. The
Mineral Resources and Petroleum Authority of
Mongolia, an independent agency within the
Ministry, is the lead minerals agency.44
44 The Mineral Resources Authority of Mongolia is responsible for issuing minerals licenses, compiling information on the minerals indus-
try, archiving geological data, and conducting geological surveys and research
45 The World Bank 2004, p. 55.
46 The World Bank 2007, p. 131
Despite its manifest strengths, the World Bank has
noted that this legal and organizational framework
has significant weaknesses. 45
‘• There are no regulations that lay down (a) the
rules and procedures for local government and for
land-user permits/contracts; (b) the rules for
provincial governors to approve environmental
submissions; and (c) the rules for the notification
and enforcement of sanctions for license violations.
‘• The framework fails to specify adequately the
form and content of reports on the obligations of
licensees, or on the requirements for initial feasi-
bility studies.
‘• There is poor coordination between central gov-
ernment agencies, as well as different levels of
government.
‘• Artisanal mining is outside the framework created
by the Minerals Law. The specialized legislation
that was meant to be developed to regulate arti-
sanal mining has yet to be implemented by the
Mongolian government.
Sweeping amendments enacted to the Minerals Law
in 2006 have introduced further and more serious
weaknesses. The principal ones are the introduction
of the concept of Strategic Mineral Deposits and pro-
viding for the government to compulsorily obtain or
acquire equity in such Deposits.46 To do so, the 2006
amendments have defined two acquisition options:
‘• acquisition of up to 50 percent of the equity in
‘Proven Reserves’ — these are reserves identified
by exploration that was financed by the govern-
ment;
‘• acquisition of up to 34 percent of any other min-
ing operation that is deemed to be of ‘strategic
importance’ to the Mongolian government.
A mining operation is deemed to be of strategic
importance where it has:
‘…a potential impact on national security, eco-
nomic and social development of the country at
national and regional levels or deposits which
Mining Report on Mongolia — Averting the Resource Curse • 29
 are producing or have the potential to produce
above 5 percent of Gross Domestic Product of
the year.’
These new provisions will require a substantial body
of implementing regulation to clarify the practical
application of the new Law. They include:
• definition of what a ‘proven reserve’ is, and of the
criteria to establish them;
• the rights of the government with respect to
deposits with only a small share of proven reserve
identified by government exploration expenditure;
• the extent of the equity that is to be acquired by
the government and how it is to be valued and
47
financed.
In 2002 public policy in Mongolia was focused on mak-
ing its mining sector more market-orientated. With few
exceptions, state-owned mining companies have been
unsuccessful in terms of their operational efficiency,
risk exposure and public financial liability.48 The gov-
ernment of the day, however, baulked at privatizing
Erdenet and Mongolrostsvetment because of their size
and their importance to the Mongolian economy. The
most recent legislative changes to allow the Mongolian
government to obtain or acquire equity in other mining
developments represent a step backward.
The Minerals Law allows the government to enter
into an investment agreement
with a mining licensee to:
• fix the rates of corporate income tax, customs
duty, VAT and minerals royalty that apply to the
mining project; and
• ensure the licensee’s right to export and sell the out-
put from the project on world markets, and to receive
and dispose of any hard currency from the sales.49
47 The World Bank 2007, p. 132
48 The World Bank 2008, p. 18
49 Such Agreements were formerly known as Stability Agreements (The World Bank 2007, p. 124)
50 The time limits are 10 years for investment projects of US$50-US$100 million, 15 years for projects of US$100-US$300 million and 30
years for projects involving more than US$300 million (The World Bank 2007, p. 124)
51 The World Bank, 2007, p. 124
52 The World Bank 2004, p. 109
53 The World Bank 2004, p. 109
54 This section draws heavily on The World Bank 2004, 2007 and 2008, as well as information published by Ivanhoe Mines Limited at its
corporate website [accessed at www.ivanhoe-mines.com ].
55 The World Bank 2004 and Ivanhoe Mines Limited, 2008, Oyu Tolgoi Gold and Copper Project, Southern Mongolia [accessed at
www.ivanhoe-mines.com/s/OyuTolgoi.asp ]
30 • Mining Report on Mongolia — Averting the Resource Curse
The 2006 amendments to the Minerals Law allow
investment agreements to fix specific tax rates for
defined but limited periods of time. The length of
time depends on the quantum of total investment that
is to be made by the mining company in question.50
To date, the Mongolian government has concluded
stability agreements with three companies under the
1997 Minerals Law while others are being negotiated
currently51 The World Bank has observed that there is
disagreement within the Ministry of Finance as to
whether these agreements protect a mining licensee
against the imposition of new taxes or allows the
licensee to benefit from favorable tax changes, such as
reductions in tax rates.52
The World Bank has also noted that there is disagree-
ment within the Mongolian government about how
much discretion the Minister of Finance has in negoti-
ating investment agreements. This disagreement has
even cast doubts over the legal validity of one of the
agreements that has been executed by the Minister.53
5.3 Oyu Tolgoi Project54
Oyu Tolgoi is a world class copper and gold deposit
that represents the most significant mineral discovery
that has been made in Mongolia since independence.
Its mineral licenses are located in the South Gobi
Desert, approximately 80 km north of the Chinese
border and about 600 km due south of Ulaanbaatar.
They are owned by Ivanhoe Mines, a Canadian min-
ing company.
Ivanhoe Mines has been the biggest mineral explorer
in Mongolia. It owns or controls mineral rights cover-
ing approximately 62,000 km2. The company spent
around US$8 million on mineral exploration in
Mongolia in 2002 and has spent nearly US$900 mil-
lion in-country since 2001.55 Ivanhoe Mines is devel-
oping the Oyu Tolgoi project in a strategic partnership
with Rio Tinto plc.
The Oyu Tolgoi mineral licenses do not have access to
water, power or transport and will require substantial
investment in infrastructure to make the project oper-
ational. The mine’s output of copper concentrates will
probably be exported to smelters in China, and would
benefit from construction of a 290 km rail link from
the mine to the Chinese railway network. The nearest
power station is 200 km away at Tavan Tolgoi. Water
for the project would have to be pumped from the
Galnyn Gobi and Gunii Hooloi aquifers, which are
about 70 km from Oyu Tolgoi.
The development of the mine is expected to take place
in two phases over a 15-year period. The mine should
have a life of more than 45 years and should involve a
total capital expenditure of around US$7.5 billion
over the life of the project.56
The first phase consists of the construction of an
open-pit mine on the Southern Oyu Deposits, a 200
MW power plant, and a milling complex capable of
processing between 85,000 and 100,000 tons of ore
per day, at an estimated capital cost of US$2.7 billion.
The second phase involves sinking an underground
mine at the Hugo Dummett Deposit and expansion in
ore processing capacity, at an estimated capital cost of
US$1.3 billion.
The two mines are expected to produce an average
annual output of 500,000 tons of copper and
330,000 ounces of gold for at least 35 years. Peak
annual production is expected to exceed 700,000 tons
of copper and 900,000 ounces of gold.
For the past four years, successive Mongolian govern-
ments have been trying to conclude an investment
agreement with Ivanhoe on the Oyu Tolgoi project
under the Minerals Law.57 A draft of the proposed
agreement was finally submitted to the State Great
56 Ivanhoe Mines limited, 2007, Reference Facts: Oyu Tolgoi Project, 27 June, [accessed at www.ivanhoe-mines.com/i/misc/OTFact.pdf ]
57 Trish Saywell, 2008, ‘Waiting for Godot – in Mongolia: Nerves are fraying at Oyu Tolgoi, as government dithers on investment agree-
ment’, The Northern Miner, 21-27 January [accessed at www.northernminer.com ].
58 The State Great Hural is the unicameral Mongolian Parliament (The World Bank 2008, p.10).
59 At the time the joint Parliamentary-Government Working Group was asked to make its suggestions and recommendations to the
Government by 5 February 2008 (The World Bank 2008, p.10)
Hural for discussion in July 2007 but the government
withdrew it in December of that year.58 In January
2008, the government set up a joint Parliamentary-
Government Working Group to revise the proposed
agreement for the Oyu Tolgoi project. The joint
Working Group will also purportedly revisit the
investment agreements that have been proposed for
the Tavan Tolgoi coal mine and the Asgat silver
deposit.59
5.4 Proposed Investment Agreement
The proposed agreement is to formalize and regulate
the relationship between the Mongolian government
and Ivanhoe Mines for a period of 30 years and
beyond. The project is to be implemented in two
phases with the open pit commencing operations in
2010 and the underground mine in 2014.
The main provisions of the proposed agreement are
concerned with:
• the maintenance of a stable tax environment for
the project;
• guaranteeing Ivanhoe Mines the right to sell the
output on world markets;
• guaranteeing Ivanhoe Mines the right to apply its
income from those sales at its discretion;
• the amount and term of the proposed investment
in the project;
• ensuring the mining does minimum damage to
the environment and human health;
• the rehabilitation of the environment at the end of
the project;
• ensuring the project does not adversely affect
other industries or other mining operations;
• the development of the Oyu Tolgoi region and the
creation of new jobs in Mongolia;
• compensation for any damages to property that
may be caused by the project;
• the process for terminating the investment agree-
ment; and
Mining Report on Mongolia — Averting the Resource Curse • 31
 Proposed tax Treatment for Oyu Tolgoi Project
Table 8
Tax Provision Tax Rate or Allowane

Corporate income tax

Rate on taxable income less than Tg3.0 billion Standard rates (a)
Rate on taxable income in excess of Tg3.0 billion Standard rates (a)
Rate on taxable income from dividends 10%
Rate on taxable income from royalties 10%
Rate on taxable income from disposal of immovable property 2%
Rate on taxable income from interest 10%
Rate on taxable income from sale of a right 30%
Carry forward of tax losses Up to 5 years (b)
Tax credit on investment in fixed assets in Mongolia 10%
Expenditure on mineral exploration Amortized over 5 years
Depreciation of assets Straight line basis
Expenses in holding or transferring a mineral licence Amortized on straight line basis
Expenditure on mining royalties Standard rates (a), tax deductible
Expenditure on mining licence fees Depreciable as a fixed asset
Windfall tax
Rate on gold output Nil (c)
Rate on copper output Nil (d)
Withholding tax
Rate on income to non-residents from sale of goods, labour or services 20% (e)
Rate on dividends paid to Ivanhoe Mines or to Rio Tinto Nil
Rate on dividends paid to other shareholders Standard rates (a)
Personal income tax
Rate on income to foreign workers on Project 10%
Rate on income to Mongolian workers on Project 10%
Value-added tax
Rate on materials, plant & equipment during construction period Nil (f)
Rate on goods & services exported from Mongolia Nil
All other goods & services Standard rates (a)
Customs & excise duties
Rate on petrol & diesel fuels Standard rates (a)

Notes:
(a) the applied tax rates are the standard rates specified by the relevant Mongolian law
(b) amount deducted in any tax year not to exceed 50 percent of the taxable income in that year
(c) subject to the gold being offered for sale to Mongolian Central Bank at world prices
(d) subject to a copper smelter with a capacity of 500,000 tonnes per annum being built in Mongolia within
five years of open pit operations at the Oyu Tolgoi Deposit.
(e) only applies to income earned in Mongolia
(f) includes spare parts, motor vehicles and aircraft but excludes sedan vehicles
Source: Draft Investment Agreement 2007

• the rights and obligations of the parties during
the exploration, extraction and processing opera-
tions at the Oyu Tolgoi Deposit.
The key taxation provisions that are to apply to the
project are set out in Table 8. In addition, mining roy-
alties are to be levied at the standard rate (5 percent)
in the Minerals Law. The most significant departures
from the standard tax treatment of the mining sector

32 • Mining Report on Mongolia — Averting the Resource Curse

under Mongolian law, are in the proposed rates for the
windfall profits tax and the withholding taxes, as well
as the provision to allow tax losses to be carried for-
ward to future tax years for up to five years.
The Mongolian government proposes to extend to
Ivanhoe Mines the benefit of any law or regulation
that it may enact following execution of the invest-
ment agreement. This treatment also extends to any
international treaty that Mongolia may enter subse-
quently.
The Mongolian government considers the Oyu Tolgoi
Deposit to be a mineral deposit of strategic impor-
tance as defined by the 2006 amendments to the
Minerals Law.60 This allows the government to
acquire 34 percent of the equity in the Oyu Tolgoi
Project. The proposed investment agreement includes
a provision to this effect with the terms of the acquisi-
tion to be set out in a schedule to the agreement. The
acquisition would be funded by a loan to the govern-
ment from Ivanhoe Mines.
Following the national elections in Mongolia in 2006,
the new central government is now considering
increasing the equity to be acquired in the Oyu Tolgoi
project to at least 51 percent and raising the existing
state equity in the Tavan Tolgoi coal mine to 100 per-
cent. Meanwhile there have been calls within
Mongolia for a review of the country’s mining tax leg-
islation.61
Ivanhoe Mines is to conduct comprehensive environ-
mental monitoring and analyses on the project and to
report the results to the environmental authorities
twice a year. The company is to eliminate any adverse
impact at its expense and pay compensation for any
direct environmental damage.
The Mongolian government is to grant the company
permits to use any water resources, which it has dis-
covered, for the project but the water resources shall
be subject to some public use as well. The contract on
water utilization is to have a term of not less than 20
years and extension periods of five years. Such use is
60 The Mongolian government’s determination takes into account the possibility that the output from the Oyu Tolgoi Project could affect
national security as well as the economic and social development of Mongolia at the national and regional levels, or could generate more
than 5 per cent of Mongolia’s GDP each year.
61 The World Bank 2008, p. 10.
to be in accordance with a water resource study
approved by the environmental authorities and on the
basis of fees specified by the relevant Mongolian law.
The government is prepared to supply electric power
to the project from the Central Energy Grid. When
developing its strategy on power supply for the Project,
Ivanhoe Mines will try to reach a shared solution with
the government based on the government’s reasonable
proposal. That said, the company will be able to install
and operate power generation facilities in Mongolia at
a site most appropriate to the project. The parties
agree that such power will be available for the short
and long-term power requirements of the project dur-
ing its construction and operational phases.
Ivanhoe Mines is to construct an international road
between the Project and the border crossing to China
at Gashuun Sukhait on the following terms and con-
ditions:
• The route is to be agreed upon with the govern-
ment, but is to be as cost-effective and as direct as
possible.
• The company will fund construction of the road
and the funds will be deducted from its taxable
income.
• The government will be responsible for maintain-
ing the road at its cost and for charging and collect-
ing road user fees from third parties.
• The company will for the duration be exempt from
all road user fees.
• The government will hold sole legal liability for the
road.
Ivanhoe Mines is to employ Mongolian nationals. No
more than 25 percent of its construction workforce
and no more than 10 percent of its operational work-
force are to be foreign nationals. If not, the company
is to pay a fee equal to ten times the minimum month-
ly salary for each foreign national in excess of the
specified percentage. The fee is to be used train
Mongolian nationals, in accordance with an agreed
training program.
Mining Report on Mongolia — Averting the Resource Curse • 33
All investment in Mongolia by Ivanhoe is to enjoy the
legal protection guaranteed by the Mongolian
Constitution, its Foreign Investment Law and other
legislation, which is consistent with those laws and as
guaranteed by the international treaties to which
Mongolia is a party. None of the company’s property
34 • Mining Report on Mongolia — Averting the Resource Curse
or assets is to be expropriated except for public pur-
poses or interest and only in accordance with due
legal process on a non-discriminatory basis with full
compensation. It is to be entitled to conditions no less
favorable than those granted to the Mongolian
investors.
6. Conclusion
The environment for investment in mining in
Mongolia is simply not competitive in terms of its
ability to attract international investment. Moreover,
the current environment is a long way from being
internationally competitive.
This lack of international competitiveness in mining
investment represents a major economic cost for ordi-
nary Mongolians, given their economy’s heavy
reliance on mining, both directly and indirectly, and
their country’s extensive and rich geological potential.
Realization of this geological potential will require
enormous quantities of capital and sophisticated
‘know how’, neither of which Mongolia currently pos-
sesses or is likely to possess in the foreseeable future.
This will leave the industry in Mongolia subject to
being directly influenced and dominated by Chinese
and Russian companies that do not observe the same
standards of transparency as western companies.
The Oyu Tolgoi project represents a microcosm of the
issues. Oyu Tolgoi is a world class deposit that could
be developed into the largest mine of its type in the
world but this one project will require investment of
more than US$7 billion. Given the scale of the project
and the nature of the Mongolian investment environ-
ment, the owner of the Oyu Tolgoi mineral licenses has
indicated that the Mongolian government needs to
‘lock in’ appropriate tax and regulatory parameters if
the project is to proceed. Without adequate protection
from inappropriate policy measures and policy set-
tings, both immediately and over the longer run, the
project will likely need to be postponed indefinitely.
Any delay runs the risk of missing out on the benefits
of the current favorable commodities market, at great
expense to the Mongolian people and the company.
Mongolia’s lack of international competitiveness in min-
ing investment is a reflection of a number of factors:
• Mongolia’s institutional foundations are not yet
well developed. While it has made good progress,
62 The Index assesses 162 countries around the world on each of ten individual freedoms. They include the freedom to trade, to conduct a
business, and to invest, as well as the extent and security of property rights. Countries are graded on scores between 0 and 100 for each
freedom. The individual freedom scores are combined with equal weightings to produce an overall score for each country.
63 Heritage Foundation, 2008, ‘Mongolia’, 2008 Index of Economic Freedom Website, The Heritage Foundation & Dow Jones Inc,
Washington DC, [accessed at http://www.heritage.org/research/features/index/country.cfm?id=Mongolia ]
the country is still in the process of establishing
secure property rights, economic freedom and
democratic government.
• The policy framework that Mongolia currently
applies to its mining sector has a number of funda-
mental flaws. The mining taxation regime is exces-
sive and the regulatory regime allows the govern-
ment effectively to confiscate substantial amounts
of equity in mining projects.
• In theory the flaws in the mining policy framework
can be neutralized by the Mongolian government
negotiating an agreement with a prospective
investor to ‘lock in’ key tax and regulatory parame-
ters for a project. The experience to date suggests
that this is a false hope.
Each of these points is elaborated below.
6.1 Weaknesses in Mongolian Institutions
Since the demise of the Soviet Union, Mongolia has
been in the process of transforming its institutional
base so as to establish secure property rights, the rule
of law, economic freedom, and democratic govern-
ment. While it has made generally good, if uneven,
progress in establishing the institutions required for a
market economy and democratic governance,
Mongolia has some way to go.
A proxy for this gap in institutional development is
provided by the Index of Economic Freedom, which is
published annually by The Heritage Foundation and
the Wall Street Journal. The Index is used to measure
the strength of a country’s institutions from the per-
spective of what it means for economic freedom.62
In the 2008 Index of Economic Freedom Mongolia
was ranked as the world’s 62nd freest economy (out of
162 countries).63 Its overall score was 3 percentage
points higher than in 2007, which mainly reflected
improved scores in four of the ten economic freedoms
measured by the Index. Mongolia was ranked 10th
out of 30 countries in the Asia-Pacific region; its score
is slightly higher than the regional average.
Mining Report on Mongolia — Averting the Resource Curse • 35
Overall Mongolia scored relatively well in terms of
fiscal freedom, financial freedom, business freedom,
investment freedom and trade freedom but was very
weak in terms of its protection of property rights
and its freedom from corruption.
The Heritage Foundation’s report for 2008 conclud-
ed that the enforcement of laws protecting private
property in Mongolia was weak. Its judges general-
ly did not understand commercial principles, such
as sanctity of contract and private property rights,
and regularly ignore the terms of contracts in mak-
ing decisions. Moreover, the legal system did not
recognize the concept of collaterized assets and
Mongolia does not have a mortgage law.
The 2008 report found that corruption was per-
ceived as being widespread in Mongolia.
Transparency International ranked Mongolia in
99th place (out of 163 countries) on its Corruption
Perceptions Index for 2006.64 Corruption is both
significant and growing. Allegations of public-sec-
tor corruption include cases involving cabinet-level
officials.
Corruption and weak property rights severely add to
the risks of investing in Mongolia and thereby limit
the country’s ability to attract international invest-
ment to develop its extensive mineral resources.
This has been confirmed by the political risk assess-
ment of countries of import to the mining industry,
which is compiled annually by Behre Dolbear, an
international mining consultancy.65 In 2008 Behre
Dolbear ranked Mongolia towards the bottom of its
results in terms of the quality of its political system
(a score of 4 on a ten-point scale) and freedom from
corruption (3 on a ten-point scale).
6.2 Weaknesses in Mining Policy Regime
The lack of international competitiveness of the
mining policy regime in Mongolia has been consis-
tently underlined by the surveys by The Fraser
Institute, as well as the results of extensive empirical
research, much of which has been conducted by or on
behalf of international organizations such as The
World Bank.
The principal weaknesses that have been highlighted
in the policy regime are excessive levels of mining tax-
ation and a regulatory regime that allows the nation-
alization of part of the equity in a mining project.
In 2007-08 the companies surveyed by Fraser ranked
the Mongolian mining policy regime as the 8th worst
in terms of its investment attractiveness. This is in
sharp contrast to the regimes in other mineral-rich
developing countries, such as Chile and Botswana,
which were at the top of the rankings. Papua New
Guinea, on the other hand, has shown how even selec-
tive mining policy reforms, when well targeted, can
dramatically improve a country’s standing.
Mongolia’s overall ranking improved significantly
between 2004-05, when it was assessed for the first
time, and 2005-06. In 2006-07, however, Mongolia’s
ranking collapsed dramatically in the wake of the
2006 changes to its regulatory and tax regimes for
mining. As a consequence its overall ranking fell from
33rd (out of 64 countries) to 62nd (out of 65) in
2006-07, where it more or less remained in 2007-08.
The gap in competitiveness between the Mongolian
policy regime and international best practice has been
confirmed by empirical research, much of it published
by The World Bank, the International Monetary Fund
and the Asian Development Bank. Much of this work
has been conducted over nearly two decades by
Professor James Otto, who is a leading international
expert in mineral economics and mining law.66
Professor Otto has also undertaken an independent
analysis of the Mongolian mining policy regime, as at

64 The Index of Economic Freedom Index uses the most recent results of the Corruption Perceptions Index, which is published annually by
Transparency International, to measure freedom from corruption. .
65 Behre Dolbear, 2008, 2008 Ranking of Countries for Mining Investment: Where ‘Not to Invest’, Behre Dolbear & Company Inc, Denver,
CO, [accessed at http://www.dolbear.com/publications-countryranks.php ]
66 Professor Otto is currently Director of Graduate Studies and Research Professor at the College of Law at the University of Denver in the
United States. He has extensively advised The World Bank and United Nations on mining taxation and regulation and their economic
impacts (see Otto 1992, 2001, 2002 & 2004, and Otto et al 2000 & 2006).

36 • Mining Report on Mongolia — Averting the Resource Curse

January 2007.67 His analysis compares the major taxes
and their policy settings in Mongolia with similar
regimes in a selection of 20 leading mining countries.
In doing so, he used a model copper mine that he had
developed at the Colorado School of Mines to com-
pare the overall effect of mining taxes in Mongolia as
compared to elsewhere.
6.2.1 Excessive taxation
Based on widely accepted measures of comparison —
the internal rate of return (IRR) to the mine owners
and the overall effective tax rate (ETR) to the govern-
ment — the current Mongolian mining tax system is
simply not internationally competitive. The absence
of international competitiveness principally reflects:
• the existence of the 68 percent Windfall Profits
Tax;
• excessive rates of mining royalties and withholding
taxes; and
• the limitations on the ability of mining companies
to carry forward tax losses to future tax years.
Professor Otto has estimated that the current
Mongolian tax regime would only allow an IRR of less
than 9 percent a year based on his model copper
mine.68 Most mining companies, however, would hesi-
tate to invest in a project that did not meet the sector’s
benchmark rate of return of at least 12 percent a year.
Moreover the application of the benchmark has to
reflect the additional risks involved. Mining compa-
nies therefore seek significantly higher rates of return
for investing in high risk or high cost countries com-
pared to low risk, low cost countries. As evidenced by
the Behre Dolbear country rankings, mining compa-
nies consider Mongolia to be a high risk, high cost
investment proposition.69
The overall tax burden imposed on mining in
Mongolia is among the highest in the world. The
extent of the gap between Mongolian and internation-
al best practice is very substantial. In Professor Otto’s
estimation the ETR in Mongolia is around twice that
67 James Otto , 2007, ‘Competitive Position of Mongolia’s Mineral Sector Fiscal System: the Case of a Model Copper Mine’, mimeo, January
[accessed at http://21576430.domainhost.com/docs/Dr.%20James%20Otto%20—
%20Mongolia%20Competitive%20Tax%20Report%20%202007.pdf ]
68 Otto 2007
69 Behre Dolbear 2008.
70 Otto 2007
of best practice countries.70
Internationally a Windfall Profits Tax is without
precedent. Very few countries levy such taxes on min-
ing sector profits, let alone imposing them on top of
substantial corporate income taxes and mining royal-
ties as Mongolia has done. Papua New Guinea is one
of the few to have done so. The Papua New Guinea
government abolished its Additional Profits Tax in
2003 after it had become abundantly clear that the
Tax was seriously harming mining investment in
Papua New Guinea.
As we have seen, ‘windfall’ profits in mining perform
an essential function. They reward the entrepreneur-
ial effort that brings together the capital and sophisti-
cated know-how that is the foundation of successful
mineral developments. Taxing the rewards for that
effort makes no sense as it would substantially reduce
new mining investment in Mongolia and with it coun-
try’s best chance to accelerate economic development.
Mongolia should learn from the lesson of Papua New
Guinea by abolishing its Windfall Profits Tax and
aligning its other taxation settings with the recom-
mendations of the World Bank as set out in Table 6.
6.2.1 Excessive regulation
In 2002 public policy in Mongolia focused on making
its mining sector more market-orientated but the gov-
ernment of the day baulked at privatizing Erdenet
and Mongolrostsvetment. This was unfortunate as
state-owned mining companies have generally been
highly unsuccessful. Despite their palpable lack of
success, the most recent changes to the Minerals Law
will allow the state to expand its involvement in the
sector.
Giving the Mongolian Government the option to
obtain or acquire a substantial share of the equity in
new mining developments will be viewed very nega-
tively by mining investors, particularly international
investors. In combination with the 68 percent
Mining Report on Mongolia — Averting the Resource Curse • 37
Windfall Profits Tax, the acquisition option will dev-
astate the upside in profitability from successful min-
ing ventures and thereby drive mining investment
away from Mongolia. This perception will have been
reinforced by the government’s proposal to complete-
ly nationalize the Tavan Tolgoi coal mine and would
be reinforced even further if the government com-
pletes the acquisition.
The acquisition option has thereby added significantly
to the risks associated with minerals development.
More importantly they will accelerate the rising uncer-
tainty that is emerging over the stability of the mining
policy regime in Mongolia. This uncertainty has been
accentuated by calls for the State Great Hural to enact
further amendments to the Minerals Law so as, among
other things, to increase the amount of equity in a min-
ing project that may be acquired by the government to
a minimum of 51 per cent.
Activation of the acquisition option that is already in
the Minerals Law will reduce the financial viability of
a mining project, increase its risk and potentially
complicate its management. It will also create a con-
flict of interest between the government’s role as a
regulator of mining activity and its financial interest
in some of the operations being regulated. Most gov-
ernments have found that a combination of taxes and
royalties are less risky than public equity and that they
generate greater financial returns for the community
as a whole.
Regardless of how the terms for acquiring the equity
in question is arrived at, it will be difficult to avoid
that conclusion that the government’s negotiating
position was implicitly, if not explicitly, backed by
legalized coercion. This merely increases the negative
perception of the risks of investing in Mongolia.
In all the circumstances, the Mongolian government
should remove the option in the Minerals Law that
allows it to compulsorily acquire an equity share in a
mining development. This would be in line with
repeated recommendations by the World Bank,
38 • Mining Report on Mongolia — Averting the Resource Curse
6.3 Proposed Oyu Tolgoi Investment Agreement Not the
Solution
The Mongolian government’s latest proposals for the
draft agreement are not a solution to the flaws in the
policy regime, which have been outlined above. This
is the case whether one is looking at their implications
on the mining sector as a whole or simply for the Oyu
Tolgoi project in isolation.
The government’s latest proposals would effectively
eliminate the worst features of the Mongolian mining
tax regime as far as the Oyu Tolgoi project is con-
cerned — notably the Windfall Profits Tax. That said,
the economic gains to Mongolia from doing so would
be restricted to the Oyu Tolgoi project and only for the
first 30 years of the project.
On the other hand, these proposals would entrench
and operationalize the most serious shortcoming of
the regulatory regime for mining — namely the public
equity acquisition option in the Minerals Law. The
economic losses to Mongolia from retaining the equi-
ty acquisition option in the Law would more than out-
weigh the additional economic gains that would be
generated by the more favorable tax treatment pro-
posed for the Oyu Tolgoi project over its first 30 years.
The far more desirable policy solution is for the
Mongolian government to:
• repeal the Windfall Profits Tax;
• repeal the equity acquisition option in the Minerals
Law;
• reduce the royalty rates imposed by the Minerals
Law; and
• legislate the other tax changes, which are currently
in the draft agreement, to make them available to
all mining projects without restriction.
This approach would maximize the economic benefits
of the reforms that have already been proposed for
Oyu Tolgoi by extending them automatically to every
other mining project. It would widen those reforms
by repealing the most negative of the remaining fea-
tures of the tax and regulatory regimes.
In the context of the proposed agreement, however,
the elimination of the Windfall Profits Tax comes at
an economic cost to Mongolia, although the precise
extent of that cost is unclear.
To avoid the imposition of the Windfall Profits Tax ,
Ivanhoe Mines would have to have a 500,000 ton cop-
per smelter built in Mongolia within five years of the
commencement of open pit operations at Oyu Tolgoi.
In the absence of any legal impediment, such a
smelter would be built if it makes commercial sense.
If it does not make commercial sense, there would be
no net economic benefit to Mongolia in forcing an
uneconomic investment on Ivanhoe Mines — or any-
one else for that matter, including the Mongolian gov-
ernment. Doing so would simply divert scarce capital
from more rewarding applications, such as the subse-
quent expansion or upkeep of the Oyu Tolgoi mines.
Any acquisition of an equity share in the Oyu Tolgoi
project by the Mongolian government would be
viewed negatively by international mining investors
for the reasons that have been outlined previously.
Acquisition would also:
• undermine the financial viability of the project;
• increase the risks associated with the project;
• complicate its management; and
• create a serious conflict of interest for the govern-
ment in its roles as shareholder and regulator and
invite government corruption.
Collectively these impacts would devalue the equity in
the Oyu Tolgoi project and the devaluation would ulti-
mately be reflected in a reduction in its profitability.
As a consequence the net present value of both the
dividend and public revenue streams, which are
expected to flow from it, would be substantially lower
than would otherwise be the case.
It is time for the government to abandon the idea that
Erdenet is the ideal model for major mineral develop-
ment in Mongolia. Erdenet is a hangover from the
Soviet era of centrally planned mineral development.
It would not be commercially viable were it being
developed in the modern era of mining. Accordingly
it does not provide any insight into successful miner-
al developments by mining enterprises that are truly
‘state of the art’ and commercially viable.
Government equity arrangements along the lines of
the old Soviet model at Erdenet have not proven to be
effective for the people for Mongolia and they must be
abandoned as relics of the past.
Mining Report on Mongolia — Averting the Resource Curse • 39
40 • Mining Report on Mongolia — Averting the Resource Curse
Annex A: The Taxation of Mining in Mongolia
The principal taxes that apply to the mining sector in
Mongolia are:
• corporate income tax
• windfall profits tax;
• personal income tax;
• mining royalties;
• value-added tax;
• customs and excise duties; and
• social insurance contributions.
This annex will outline the nature and extent of each
of these taxes in so far as they are applied to minerals
exploration and mining activities. It will also set out
how each one has evolved over recent years.
Corporate Income Tax
Corporate income tax is levied under the Economic
Entity and Organization Income Tax Law. Since
January 1, 2006, the general corporate income tax
scale was reduced to 13 percent on the first
Tg100 million — equivalent to US$100,000 — of tax-
able income then 30 percent on all taxable income in
excess of that amount.71 The income from certain
sources is taxed at lower rates.72 In the case of income
from mining, the rates are 10 percent on first Tg3 bil-
lion of taxable income, then 25 percent on income in
excess of that amount.
Taxable income is determined by deducting allowable
expenses form gross income. The corporate income tax
law prescribes the depreciation rates that may be used.
They range from five years on a straight line basis for
mining machinery and equipment to 40 years on a
straight line basis for buildings. Although the law is
unclear on the point, the World Bank quotes the
General Department of National Taxation as interpret-
ing the law as not requiring depreciation to be claimed
each year.73 This is an important issue for mining oper-
ations as the corporate tax law has no provision for
allowing losses in taxable income to be carried forward
to offset taxable income in subsequent years.
71 Prior to 2006 the first tax rate was 15 percent and the top marginal rate was 40 percent (The World Bank, 2007, Table 6.8, p. 124)
72 For example interest on bank deposits and income from the disposal of real property are taxed at 15 percent and 2 percent respectively
(The World Bank 2004, p. 105).
73 The World Bank 2004, p. 105.
74 The World Bank 2004, p. 106.
75 The World Bank, 2007, p. 123
76 The World Bank, 2007, Table 6.8, p. 124
The corporate income tax law does not explicitly allow
mineral exploration or pre-production development
expenses to be amortized. The World Bank has, how-
ever, quoted an official of the General Department of
National Taxation to the effect that such treatment
could be allowed in accordance with accepted
accounting principles.74
ANNEX A
Although the 1997 Minerals Law required the
Ministry of Finance to implement certain regulations
on the determination of taxable income by mining
enterprises, they were not prepared and the require-
ment to do so was removed by amendments to the
1997 Law enacted in 2006.75 These related to the leg-
islative rules that were to apply to:
• the amortization of exploration and development
expenses;
• the depreciation of fixed assets;
• a provision to carry-forward tax losses for three
years; and
• the deductibility of infrastructure expenses.
Prior to 2006, the corporate income tax gave some tax
incentives to mining:
• an enterprise with a foreign investor receives an
exemption from all income tax for five years and an
exemption from half the tax that would otherwise
be payable over the following five years; and
• where a foreign shareholder reinvests dividends in its
Mongolian company, the latter may reduce its taxable
income by the amount of the reinvested dividends.
Payments to non-residents are generally subject to a
withholding tax of 20 percent.76 The rate of withhold-
ing tax is reduced under double taxation treaties with
other countries. As of January 1, 2002, Mongolia had
double taxation treaties with 24 countries.
Windfall Profits Tax
In 2006 the Mongolian government introduced a tax
on windfall profits from copper and gold production
due to favorable commodity price movements.
Mining Report on Mongolia — Averting the Resource Curse • 41
 A flat rate of 10 percent was introduced on personal income
payable from 1 January 2007 and income payable as dividends
and interest after 28 December 2007 will not be taxed until 2013.
Personal income tax
Table 9 rates, Mongolia
Tax Rate (%)
Less than Tg2.4 million [US$2,400] 10
Tg2.4 million to Tg4.8 million [US$4,800] 20
More than Tg4.8 million 40
Source: The World Bank 2004, p. 106
The tax is triggered when world prices exceed certain
thresholds — US$6,500 per ton in the case of copper
and US $500 per ounce for gold.77 These price thresh-
olds are not indexed for inflation and are relatively
low compared to current prices. For example, the
average world price of copper for the month of
February 2008 was US$7,886 per ton and the price of
gold for that month was US$924 per ounce.78
The tax rate is levied at a rate of 68 percent.79 In 2006
it generated $152.4 million in revenue for the govern-
ment.80 The volume of gold production in Mongolia
recorded for that year by the Statistical Office was
lower than for the previous year. This possibly reflect-
ed an increase in gold smuggling due to the introduc-
tion of the windfall profits tax.81
Personal Income Tax
The Personal Income Tax Law taxes individuals on the
basis of their residency and their world-wide income.
A resident includes anyone who is in Mongolia for
more than 183 days. Tax contributions are withheld by
employers and remitted to the Mongolian tax author-
ities every month. The rates of personal income tax
are set out in Table 9.
77 ADB [Asian Development Bank], 2007, Asian Development Outlook 2006, Asian Development Bank, Manila The Philippines, p. 149
78 The February 2008 copper price was sourced from the London Metal Exchange [accessed at www.lme.co.uk/dataprices_historical.asp ]
and the equivalent gold price from the London Bullion Association [accessed at www.lbma.org.uk/2008monthlygold.htm ]
79 The World Bank, 2007, p. 123
80 ADB 2007, p. 149
81 ADB 2007, p. 149
82 The World Bank 2004, p. 107.
83 The World Bank 2004, p. 107.
84 Prior to 1 January 2007 the VAT rate was 15 percent (The World Bank 2007, p. 124).
85 The World Bank 2004, p. 107.
42 • Mining Report on Mongolia — Averting the Resource Curse
Mining Royalties
The Mineral Law of Mongolia imposes an ad valorem
royalty on the gross value of all mineral production.
Prior to 2006, the royalty rate was 7.5 percent of the
value of placer gold and 2.5 percent of the value of all
other minerals. Following the enactment of amend-
ments in 2006, the royalty rate was set at 5 percent for
all minerals except placer gold.
The Income Tax Law of Mongolia does not explicitly
allow mining royalty payments to be treated as
deductible expenses for income tax purposes.
Nevertheless, the World Bank has quoted an official of
the General Department of National Taxation as indi-
cating that the department would allow the
deductibility of such expenses.82
Value-Added Tax (VAT)
Mongolia levies a VAT on most goods and services.
The World Bank has concluded that the Mongolian
Value Added Tax Law incorporates the main princi-
ples of modern VAT legislation.83 As of January 1,
2007 the rate of tax is 10 percent.84
Any VAT paid on goods or services that are exported
is fully refundable on a monthly basis. The General
Department of National Taxation has, however, pro-
posed an amendment to the VAT Law that, in effect,
would prohibit non-producing companies from regis-
tering for VAT purposes. This proposal would deny
VAT refunds to mining companies during the explo-
ration and development phases. Moreover, the World
Bank has indicated that it is not known whether the
VAT that paid during those phases would be recover-
able once they commence production.85 Most other
VAT jurisdictions do allow any recovery of any VAT
that is paid prior to registration.
Prior to January 1, 2007 major exporters and selected
industries were eligible for an exemption from VAT
on imported heavy equipment. Although the mining
 Social insurance contribution rates, mining sector, percent of payroll
Table 10
Social Insurance Fund
Pension
Unemployment
Disability
Workplace accident & disease
Health
Total contribution by mining sector
Source: General Department of Social Insurance as quoted in The World Bank 2004, p. 108
sector qualified for the exemption while it existed, its
experience with it was unfavorable — see the follow-
ing discussion on customs and excise duties where an
equivalent exemption which has been continued.
The sale of gold in Mongolia has been exempt from tax
since July 2002. A consequence of this exemption is that
gold exporters do not receive any refunds of the VAT paid
on the goods and services, which they purchase. (They
do, however, qualify for the heavy equipment exemption
from customs duties, which is discussed below).
According to the World Bank, this treatment puts a
Mongolian gold producer at a competitive disadvantage
compared to producers in other countries.86
Customs & Excise Duties
Under its Customs Tariff Law, Mongolia imposes a
duty of 5 percent on most imports. An exception from
customs duty is extended to heavy equipment, which is
imported by major exporters and selected industries.
The mining sector qualifies for the exemption but its
experience with it has been less than favorable. The
list of eligible equipment did not include drilling
equipment and the taxation authorities dispute
whether the duty exemption applies to contractors to
mining companies.87 Two Russian-owned mining
companies are exempt from customs duties under a
1991 intergovernmental agreement between
Mongolia and Russia.
Excise duty is levied on passenger vehicles, alcohol,
tobacco products, petrol, and diesel fuel. Petrol is
86 The World Bank 2004, p. 107.
87 The World Bank 2004, p. 107.
88 The World Bank 2004, p. 108.
Mining Employers (%) Mining Employees (%)
13.5 5.5
0.5 0.5
1.0 1.0
2.0 0.0
3.0 3.0
20.0 10.0
taxed at US$11 per ton for octane ratings below 90
and US$12 per ton for octane ratings above 90. The
rate for diesel fuel is US$15 per ton.
Social Insurance Contributions
The social insurance program in Mongolia has five
components — aged pension; unemployment; dis-
ability; workplace accidents and diseases; and health
— each of which is financed by a separate fund. All
five funds are administered by the General
Department of Social Insurance within the jurisdic-
tion of the Ministry of Labor and Social Care.
Contributions to the various social insurance funds
are made by both employers and employees thor-
ough a system of payroll deductions. The contribu-
tion rates by each employer to the workplace acci-
dent and disease fund depends on the risk rating of
the employer’s industry.
In the mining sector, the social insurance contribu-
tions by employers and their employees totaled
20 percent of payroll in 2002. The sector’s contribu-
tion rates for each of the funds in that year are set out
in Table 10.
The World Bank has noted that, at that time, the
Mongolian government was contemplating increasing
the risk rating of the mining sector for employer con-
tributions to the workplace accident and disease fund.88
This would have the effect of increasing their contribu-
tions to that fund from 2 to 3 percent of payroll.
Mining Report on Mongolia — Averting the Resource Curse • 43
 About World Growth
World Growth is a non-profit, non-governmental organization established with an educational and charitable mis-
sion to expand the education, information and other resources available to disadvantaged populations to improve
their health and economic welfare. At World Growth, we embrace and celebrate the new age of globalization and
the power of free trade to eradicate poverty and improve living conditions for people in the developing world.

Our Philosophy
World Growth believes that helping the developing world realize its full potential is one of the great moral aims for
those of us fortunate to live in the wealthy developed world. We also believe that a misdiagnosis of what ails the under-
developed world has yielded policy prescriptions that have been useless or even harmful to the world’s “bottom billion.”

World Growth believes that there is enormous untapped human and economic potential around the world. In order
to unlock that potential, and allow the poorest of the world’s poor a better life, it is necessary to realize changes in
institutions and policies that permit growth and human flourishing.

Instead of aid and handouts, what the populations of developing countries need are social and political institutions
and infrastructure that foster productive economic activity and generate robust economic growth. These include,
but are not limited to, property rights and protections, the rule of law, free markets, open trade, government
accountability and transparency.

For too long, well-meaning governments, aid agencies and others have promoted policies that fail to address the
true problems that afflict poor societies. As a result, too many people around the globe remained locked in pre-mod-
ern conditions where their talents and inherent capacities are shackled.

The people of the developing world are fully capable of helping themselves to ensure a more prosperous existence.
The path to prosperity does not begin with handouts from the West. Instead it requires identifying the genuine
obstacles to growth and highlighting paths to reform that will yield sustainable and lasting change.

The Real Climate Threat to Developing Countries — Early, Deep Cuts in Emissions
December 2007
 PO Box 3693
Arlington, VA 22203-3693
(866) 467-7200

www.worldgrowth.org