Politics once again takes centre stage in Chile

Rumbles from the Halls of Congress

With copper prices at all-time lows, Exxon’s attempted sale of the Disputada operation in a Caribbean tax haven for US$1.3 billion did not wash well among some of Chile’s politicians.

While Exxon saw a potential loophole to avoid paying taxes, Chile’s government soon filled that gap by sending a law project to Congress to penalize the offshore sale of Chilean companies with high taxes. The legislation, which would have made Exxon liable for some US$300 million in taxes, was said to be “made-to-measure” for the Disputada. Exxon soon backed off and agreed to pay US$40 million in taxes required by the Chilean tax office by bringing the transaction back onshore.

According to Carlos Vilches, president of Congress’ Mining Commission, the Disputada case shows that Chile’s current mining legislation is flawed. “There is no clear answer as to why they never made a profit, and people cannot understand why Disputada is now being sold for so much money,” Vilches said.

Hosain Sabag, a Christian Democrat senator, argues that methods such as accelerated depreciation and corporate offices in offshore locations allow foreign mining companies to make a mockery of Chile’s current tax regime. “These distortions are created by our Law 600 Decree (foreign investment law) which grants tax exemption,” he said.

The Christian Democrats have traditionally been the strongest political party in Chile and are currently part of the ruling coalition. At present, they have a committee looking at ways of modifying Chile’s tax regime, over which Codelco president Juan Villarzu presides. One of the main ideas that the Christian Democrat committee is pondering is to apply a royalty to mineral extraction in Chile net of cash costs.

Said Sabag: “If we can’t modify Law 600, we can apply a royalty for non-renewable products. In fact, all countries apply a 3, 4 or 5% tariff on the extraction [of minerals], so this is not a new tax, just a right that would imply Chile could bring in more than US$300 million in extra revenue.”

Senator Sabag, like Chile’s current president Ricardo Lagos, says that Chile should not raise taxes for foreign investors, which would inevitably dent confidence in the country. This, given the downward economic trend that is afflicting most of South America at present, is something Chile is trying to avoid at all costs.

Lagos has gone one further, saying that his government will not apply royalties during his term of office. But the wheels are in motion for the presidential elections of 2006, with several congressmen saying that a potential change to the current mining tax regime could take place then, affecting future investments.

Many of Chile’s mining institutions are against the move, and say the current wave of political pressure on foreign mining companies is damaging the country’s image overseas. William Hayes, president of Chile’s Mining Council, is one of those in favour of maintaining the status quo. “The Mining Council’s position is that changes to rules could be not only damaging to the mining sector, but to the image of the country outside Chile and to foreign investors in general.”

Cochilco–the government’s copper statistics unit–believes that the meager income from tax revenue is due to the fact that many foreign investors only started operations in the 1990s. The private sector is set to pay US$4.49 billion in taxes over the next nine years, Cochilco says, basing its estimates on an average copper price of US$0.87 between now and 2010. Cochilco’s Patricio Cartegena said the benefits that companies enjoy in the early years would begin to wear off, as the majority of current mines started during the copper boom of the mid-1990s.

The Response from Canadian Companies

“If a royalty or increase in taxation is imposed on mining, it would certainly have a negative impact on the exploration and development of new projects, such as our El Morro project,” said Fernando Porcile, senior vice-president, copper for Falconbridge Ltd.

Falconbridge, which owns 44% of the Collahuasi mine in northern Chile, recently gave thumbs up to a project to expand the mine’s concentrator, as part of an overall plan to switch pits at the giant copper mine. Confidence in the conditions offered by the government was central to that decision, taken with Collahuasi partner Anglo American.

“The President has stated publicly that modifying the taxation for mining activities is not on the government agenda; therefore we expect that he will not present a proposal to the Congress of a new law imposing a mining royalty,” Porcile said.

For Barrick Gold Corp.’s vice-president of communications, Vince Borg, Chile could face competition from other countries if it were to modify its current mining policies. “The experience in Chile demonstrates that mining policies such as Chile’s that accommodate the distinctive economic reality of a mining investment are more likely to be successful in attracting mining investments,” he said. “These rules recognize that direct tax or royalty revenues from a particular mining operation are not the only, nor the best measure of a mining project’s contribution to local, regional and national economic development.”

Placer Dome, which currently operates the Zaldivar copper mine, is one of a crop of Canadian companies that hold the next generation of copper projects in Chile. Cerro Casale, a copper and gold project in Chile’s Region III, would involve a US$1.4-billion investment and would economically transform the city of Copiapo, which lies to the south of Chile’s main mining district.

“Like many other mining projects, [the start-up of Cerro Casale] is very sensitive to metals prices. Inasmuch, whatever additional cost–be it a royalty or higher taxes–would make that investment less attractive from an economic point of view,” said Felipe Ruiz, director of public affairs for Placer Dome Latin America. “We think [royalties] would be a serious error, given mining does not enjoy any special tax regime compared to other sectors of Chile’s economy,” he continues. “In the worst case it would destroy the very wealth that has aided so much in the development of the country’s regions.”

Don’t forget the FTA. The close economic and political relationship between Canada and Chile led to the signing of a bilateral free trade agreement between the two countries in 1997. One of the core areas of the agreement was a principle that entitles Canadian companies to the same investment rules as domestic companies, making it difficult for a future Chilean government to introduce unique laws for foreign investors. Canadian investors in Chile and their investments are entitled to the same treatment as domestic investors and their investments, whether in the acquisition, management, operation or sale of investments.

The Law of Economics

Debating a change to Chile’s mining legislation is to speak hypothetically, and the government has expressed its reluctance to change the rules to those companies that have created so much regional wealth. The law of economics is likely to win. With Peru starting to negotiate a free trade agreement with Canada, Chile could perhaps start to lose its shine as the preferred investment location in South America.

On the other hand, if Chile boldly goes ahead with reforms and still offers the most attractive conditions in the region–providing base metals prices improve–it will undoubtedly emerge as the winner.

Matthew Craze is editor of CRU International’s web site Crumonitor.com, based in London, U.K. He is a freelance writer who spent five years based in Santiago, Chile, working for the local publications News Review and Business News Americas.