Tax Alert

Mining Royalty - Income Tax Treatment

July 2023 In Brief Historic position - acceptance of royalty

• Royalty is a mandatory contribution as deductible on general principle
imposed under the Mining Act, 2010 Historically, there had never been
• International best practice, and the any contention in Tanzania as to the
Best practice historic treatment in Tanzania, is deductibility of royalty for extractive
that this is a valid business cost and sector entities as a business expense on
is for royalty deductible in determining taxable general principle - no different to other
payments to be profit turnover based levies, whether regulatory
levies charged on turnover (such as in the
deducted from • An amendment has been made to telecommunications sector) or service levy
income that is make royalty disallowable paid to local authorities.
subject to income • The economic reality of the The basis for the deduction is the
disallowance is the same as if the
tax or to be royalty had remained deductible but
general principle of deductibility of
business expenses (as set out in the
credited against the royalty rate had been increased by Income Tax Act (ITA) 2004 (section 11(2))
income tax 43% which provides that for expenses to be
• This amendment raises several deductible, they should be incurred wholly
concerns including: and exclusively in production of income
from the business. A similar general basis
» Conceptual logic
for deduction also applied under the
» Inconsistency with international predecessor legislation, ITA 1973, which
best practice referred to expenditure incurred in the
» Economic impact (viability of production of income.
projects)
» Transparency of the tax regime

Background
A royalty expense is a legal obligation
imposed on a mining licence holder,
under the Mining Act, 2010. It is in effect a
recurring payment for the right to extract
mineral resources from the licence area -
so a right to use an asset, analogous to a
rental payment for use of a capital asset,
except that in the case of the mineral
royalty the recipient is the Government.
The cost is therefore a cost incurred
wholly and exclusively in the production of
income from a mining business.

This publication has been prepared as general information on matters of interest only, and does not constitute professional
advice. You should not act upon the information contained in this publication without obtaining specific professional advice.
This interpretation of royalty being
a cost incurred “in the production
of income” is consistent with other
mining jurisdictions. For example,
the publication “Mining Tax in
South Africa”1 by Marius van Blerck
confirms that royalty costs are
ordinarily incurred in the production
of income and so a deductible cost,
stating the following2: “This type
of cost is recurring and confers
no enduring benefit on the mining
company as the right conferred
usually lapses if payments are
not made when due. Thus, such
expenditure is, in the words of
Watermeyer CJ in the New State
Areas case...part of the cost of
‘performance of the income earning
operations’ of the mine rather than
part of the cost of ‘establishing or
improving or adding to the income-
earning plant or machinery’.”
In summary, there should be no
contention that a royalty payment is
a cost incurred in the production of
income. Accordingly on the basis of
deductibility then the net (after tax)
cost of royalty at a rate of 6% or 4%
is as follows:
Royalty Tax Net cost
rate deduction
30%
6.0% -1.8% 4.2%
4.0% -1.2% 2.8%
Revised interpretation by TRA
Following legislative changes made
in 2016 and 2017, the Tanzania
Revenue Authority (“TRA”) have
taken the position that royalty is not a
1. One of the seminal publications on the income tax principles applicable to mining | 2. See paragraph 11.11 of 1992 edition of Mining Tax in South Africa | 3. Finance Act 2016 |
4. Written Laws (Miscellaneous Amendments) Act (WLMAA), 2017 | 5. Sections 65E(1) (mining companies) and 65N(1) (oil and gas companies) of the ITA 2004 | 6. Sections 65E(2)
and 65N(2) (for mining and petroleum operations) of ITA 2004
deductible cost. This interpretation is
disputed by the mining sector.
The changes made in 2016 and 2017
were as follows:
• 2016: Introduction3 of separate
income tax provisions for (i)
mining and (ii) petroleum, and the
clause dealing with deductions
included express reference to
royalty.
• 2017: Amendment4 to remove
the specific reference to royalties
in the list of costs that are
specifically listed as deductible
expenses in calculating
income from mining/ petroleum
operations5.
The interpretation as to non-
deductibility is strongly disputed on
the basis that:
• Royalty is deductible on general
principle as a cost incurred in
the production of income. As
such there is no need for any
specific reference to it in the
deductibility provision (i.e. the
2016 amendment of introducing
an explicit reference to “royalty”
as a deductible cost was
unnecessary).
• As a valid business cost (and so
deductible on general principle),
it can only be non-deductible if
expressly listed in the provision
dealing with non-deductible
costs. However, the 2017
amendment did not amend the
provisions dealing with non-
deductible expenses6 (i.e. no
amendment was made to make
reference to royalty as a non-
deductible expense).
Recent legislative amendment
An amendment has just been made
to include royalties charged under
the Mining Act in the list of non-
deductible expenditure (as set out in
section 65E(2) ITA 2004).
This amendment was not part of
the Finance Act 2023 (assented and
published on 30 June 2023), but
was included in the Laws Revision
(Miscellaneous Amendments) Act
2023 published on 14 July 2023
(following assent on 5 July 2023).
Following this amendment, mining
royalties are no longer a deductible
cost for income tax purposes.
This amendment raises several
concerns including:
• Conceptual logic
• Inconsistency with international
best practice
• Economic impact
• Transparency of the tax regime
Conceptual logic
If the concept of corporate income
tax is as a tax on profit, then a
disallowance of royalty costs is
problematic. In particular, royalty
costs are a significant component of
the costs of a mining company - and
if disallowed means corporate income
tax applied to a figure significantly
in excess of the company’s actual
profits. Conceptually this is a
disconnect - and rather the economic
reality of such an adjustment is to
increase the royalty rate by grossing
it up at the corporate income tax
rate (100/(100-30)) - in effect a 43%
(30/70) increase (see the table below).
 Royalty treated as non-deductible
Royalty rate Tax deduction Net cost
n/a
6.0% 0.0%
4.0% 0.0%
International best practice
Mineral royalties (where based on
turnover) are generally deductible for
corporate income tax purposes in
many jurisdictions.
World Bank publication - Mining Royalties
“Mining Royalties - A global study
of their impact on investors,
Government and Civil Society”7,
a publication by the World Bank,
confirms that the normal best practice
is that “the income tax system allows
for the deduction of royalties in
computing taxable income”. It notes
that most royalty methods can be
classified as one of three types: unit
based, value based (ad valorem), or
profit based8, and that the first two
(unit based, and value based) are
the more prevalent, with profit based
royalties infrequent. Whilst the best
practice is that royalty payments are
deductible for income tax purposes
- in the infrequent cases where the
royalty payment is profit based
and more analogous to an income
tax then it may be more logical to
disallow the cost for the purpose
of calculating taxable income but
then give a credit for this against
income tax - in other words, it acts
like an advance payment of income
tax. Accordingly, in its concluding
chapter on “Recommendations and
Best Practices”9, it includes as a
best practice that the tax regime
should “allow royalty payments to be
deducted from income that is subject
to income tax or allow royalty to be
credited against income tax”.
7. ISBN-10: 0-8213-6502-9, https://openknowledge.worldbank.org/handle/10986/7105 | 8. Refer to pages 55 and 268 of the publication | 9. Refer to pages 276 to 278
of the publication | 10. https://www.pwc.com/gx/en/industries/energy-utilities-resources/mining-metals/mining-taxes-summary-tool.html | 11. https://www.pwc.com.au/
industry/energy-utilities-mining/investing-in-africa-working-together-to-maximise-the-potential.pdf | 12. https://resourcegovernance.org/blog/magufuli-seeks-right-bal-
ance-tanzania-mining-fiscal | 13. royalty, inspection fee, service levy | 14. corporate income tax, free carry interest share in distributed profits, withholding tax on dividends
| 15. Taxes / contributions not considered include employment related costs (skills and development levy, social security contributions, workers compensation fund),
corporate social responsibility, fuel taxes (embedded in fuel costs), any taxes on import not covered by existing exemptions | 16. Mine 2023:The era of reinvention
Economically equivalent gross royalty if deductible
Effective gross royalty
A A / 0.7
6.0% 8.6%
4.0% 5.7%
PwC Mining Taxes Summary Tool10
A review of various countries listed in
the PwC Mining Taxes Summary Tool
also confirms that the normal practice
is for countries to treat royalty
payments as deductible for corporate
income tax purposes.
Zambia
One past exception was Zambia
where in 2018 an amendment
(effective from 2019) was made to
explicitly disallow royalty costs, but
then this was subsequently reversed
from 2022 and royalties continue to
be deductible.
Economic impact
For a more holistic analysis it is
also important to consider the
cumulative impact of various taxes.
Even before the change to disallow
royalty costs, various studies have
shown the overall effective tax
rate / Government take can easily
exceed 70% - for example, in the
case of gold some studies have
modelled the total take at 73% (PwC
Australia11), 74% (Natural Resource
Governance Institute12). The actual
total effective tax rate depends on
project profitability, with an inverse
relationship between the two (as
a consequence of turnover taxes).
Clearly with the disallowance of
royalty, the tax take will be even
higher.
In the Appendix we have prepared
a relatively simplified analysis of
Tax deduction Net cost
30%
-2.6% 6.0%
-1.7% 4.0%
tax take that limits the tax take
calculation to taxes on turnover13
and on profit14 but not other taxes15.
It does not make any discounting
adjustment, which would inevitably
increase the calculation of
Government take further, bearing in
mind the Government receives cash
flows from inception, whereas the
investor receives cash only once a
dividend is paid. The analysis has
three scenarios as to profitability
assuming a ratio of profit before tax
to turnover of (i) 10%, (ii) 20%, (iii)
40%.
A useful reference point on financial
metrics for the mining sector is PwC’s
annual “Mine” publication. Set out in
the Appendix is the aggregate income
statement for the Top 40 Mining
companies in the last ten years as set
out in the PwC Mine 2023 Report16.
In the five years to 2022 profit before
tax as a proportion of turnover was at
its lowest in 2019 (12.9%) and highest
in 2021 (24.4%), and an average
of around 18% over the five years.
Looking back over the previous ten
years, the profitability is lower than
this. Accordingly whilst our scenario
also includes a ratio of 40%, this is
much higher (more than double) than
historic industry averages.
The summary in the Appendix shows
the following outcomes for Investor
Share v Government Share with
royalty as deductible, and now with
royalty being non-deductible:
 Investor Share vs Government Share Transparency of the tax regime
As noted above the economic reality
Assumptions on profitability 10% 20% 40% of the disallowance is the same as if
the royalty rate had been increased
Royalty allowed as by 43% (assuming the royalty to
31 / 69 39 / 61 45 / 55
deductible remain deductible).
Royalty not allowed as If looked at in comparison to
23 / 77 34 / 66 42 / 58
deductible corporate income tax, the additional
tax in the various scenarios is
Points arising from this analysis are The overriding concern is that the equivalent to the corporate income
the following: change further raises the financial tax rate increasing to 48%17, 39%18,
viability threshold for mining projects or 34.5%19 depending on the
• Even before making royalty non-
- a bar which already was very high profitability assumptions.
deductible, the Government share
- with the potential consequence
is significant If the intention is to increase
that only exceptionally high margin
Government take, then a more
• Disallowance results in a projects are viable.
transparent approach would be to
very significant increase in
have either adjusted the royalty rate
Government share
or corporate income tax rate.

17. (3 + 1.8) / 10 = 48% | 18. (6 + 1.8) / 20 = 39% | 19. (12 + 1.8) / 40 = 34.5%
 Appendix
Scenario 1: Royalty allowed as deductible

Scenario 2: Royalty not allowed as deductible

Note:
1. “Government Take” in these calculations is limited to
• Taxes on Turnover (Royalty, Inspection Fee, Service Levy)
• Taxes on Profit (Corporate Income Tax, Share in distributed profits arising from Free Carry Interest, Withholding Tax
on Dividends)
2. Taxes and other imposts generated that have not been taken into account include:
• Indirect taxes borne, for example: Fuel Taxes; Customs and Excise (to extent any items are not covered by mining
or other exemption); financing costs arising from any VAT refund lag
• Employment imposts borne: skills and development levy (SDL), employer social security contribution (NSSF),
workers compensation fund (WCF)
• Other taxes generated, including Withholding Tax (including on services and on interest), and PAYE (from
employees)
Recent Financial Performance History of Global Mining Sector20
Aggregated income statement - Top 40 - PwC Mine 2023 report
The aggregated income statement summary set out below is taken from the 20th edition of PwC’s 2023 Mine: The era
of reinvention. This publication is an annual review of the Top 40 mining companies globally and examines trends in the
mining industry. The report (on Page 42) has a summary titled “Ten-year financial trends (US$bn)” which includes this
aggregated income statement, together with aggregated cash flow statement, and aggregated balance sheet.

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20. https://www.pwc.com/gx/en/issues/tla/content/PwC-Mine-Report-2023.pdf

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