Revenue Framework: How Royalties and Fees Are Set and Collected
Where mineral resources are publicly owned, governments are entitled to collect royalties or fees for their exploration and extraction. The challenge governments face is to design a revenue framework (a specific mix of revenue sources and their associated rules) that maximizes the benefits for society while still fostering continuing private capital investments, which are necessary to realize economic benefits over the long term. In some instances, governments may decide to set royalty rates below those in other jurisdictions in order to attract investments and boost economic diversification outside of urban centres. In the end, royalty rates and fees depend on a government’s specific socio-economic objectives.
In designing revenue frameworks for the extraction of minerals, governments must establish their fiscal objectives (such as revenue stability, revenue maximization, economic efficiency, and administrative efficiency) and make a number of key decisions about which revenue sources to adopt and how each one will operate. Different revenue frameworks will accomplish different goals and will fit different circumstances. For example, a strictly volume-based royalty regime will provide predictable revenues from the start of production at a new site, but will not allow a government to benefit fully from large price increases in commodity markets. On the contrary, a profit-based royalty regime can allow governments to benefit from sharp price increases, but will not generate revenue until a company declares profits and will provide less revenue when resource prices are very low (if mines continue to operate in these conditions, which may not be the case). Governments must carefully consider which regime, whether volume-based, profit-based, or one of several other possible regimes, will be more likely to achieve their fiscal objectives. (Many factors need to be considered. For example, a regime that has a lower tax burden when prices are low may help mines to remain active for longer.)
Governments must also ensure that their royalty regime and other fees are reviewed and updated from time to time, to ensure that the rates they charge for resource extraction are still:
- competitive compared with other jurisdictions;
- aligned with fiscal and socio-economic objectives;
- reasonable, considering factors that may affect profitability, including evolving extraction technologies and environmental requirements; and
- adapted to prevailing circumstances in the mining sector.
In addition, legislation and regulations need to be in place to allocate clear roles and responsibilities to government and private sector organizations. Controls and administrative capacity also need to be established to ensure the accuracy and completeness of royalty assessments and to manage the collection of royalties and other revenues. Government departments responsible for natural resources management are often responsible for collecting royalties from the extraction of minerals, although in some instances this responsibility is shared with a revenue agency.
The collection process often requires mining companies to make monthly or quarterly payments to a government based on estimated production, sales, or profits. An annual royalty return is then filed at the end of each year. After processing and review, a company makes a final payment if there is a balance owing or it is reimbursed if it has paid too much.
While this collection process may seem simple at first glance, it can be quite complex in practice.
- Royalties are often calculated after allowable expenses have been deducted. The rules about what is and what is not an allowable expense can be quite elaborate and, in some jurisdictions, expenses for one project can be used to lower royalties owed on another project.
- Royalties owed are assessed based on information provided by private companies. To ascertain that they are receiving the correct amounts, governments must verify this information and conduct audits of production and expense data.
- Verifying royalty returns can be complicated by the fact that some commodities (unlike gold, lead, and zinc) are not traded internationally and do not have a transparent market price.
Finally, governments are responsible for ensuring that all mining companies submit their royalty payments on time and for collecting penalties and interest as prescribed by regulations.