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Overview (June 2012) - International Law Office

International Law Office

Energy & Natural Resources - Zambia

Overview (June 2012)

June 11 2012

Introduction
Nationalisation
Privatisation
Supertax
Reaching equilibrium


Introduction

Zambia is well known for its copper and cobalt mining industry and also has significant deposits of other metallic and precious minerals, including gemstones. Although it is estimated that copper and cobalt production accounts directly for only 10% of the country's gross domestic product, the indirect or derivative effect of the mining industry on the Zambian economy is probably closer to 80% or 85%.

As a result, mining remains Zambia's most important industry and receives the most regulatory attention. Since the country achieved independence in 1964, this key sector of the economy has undergone at least four stages of development: nationalisation, privatisation, a period of high taxation and a period of comparative equilibrium.

Government intervention through regulation has revolved around the question of ownership, whether direct or indirect. This Overview explores each stage of regulatory development and its effect on today's natural resources sector.

Nationalisation

Following independence, the new government rushed to transfer the main factors of production, including existing mines, from foreign to local ownership. However, in 1964 the newly independent state had only around 100 graduates and virtually no local investor population.

The government's answer was direct state ownership. This policy was implemented in the early 1970s, culminating in the formation of an overall state holding company known as the Zambia Industrial and Mining Corporation Limited (ZIMCO). ZIMCO was a company formed under corporate law, but was owned by a statutory corporation known as the Minister of Finance Corporation Sole. Acting through ZIMCO's wholly owned subsidiaries, the government gathered together all of the key privately owned companies and their businesses, from sugar refining to mining.

In principle, nationalisation appears to have been based on a sound policy, which was largely focused on funding the grand infrastructure plans of that period. The new state was able to take sovereign actions, such as nationalisation, and was limited only by the need to comply with the law.

The legislation to implement nationalisation affected:

  • the constitutional protection of property rights;
  • forms of ownership;
  • direct mining regulations; and
  • taxation.

From a constitutional perspective, the key requirement since independence has always been the entrenchment of private property rights, which the state can expropriate only by an act of Parliament and in exchange for adequate compensation. The government of the day followed the appropriate process, passing special legislation to nationalise the mines and paying what it considered to be adequate compensation to the owners.

The state chose to own the nationalised companies through the existing corporate law structure. However, the state-owned enterprises effectively had only one shareholder (ie, the government) and more closely resembled administrative bodies, controlled by government directives; in effect, their corporate status was merely symbolic.

Compliance with mining regulations by the ZIMCO-owned mines was never an issue for the government. However, as a result, the regulation of the sector remained static, largely in order to accommodate the government-owned mines. The tax treatment for mining companies was also inconsequential, as the government could collect revenue from the mines without using the tax system.

Following nationalisation, the balance of power and benefit in the mining sector was fully with the government. However, this form of ownership ultimately kept the sector stuck in the 1970s in regulatory and technological terms - a situation which was not helped by a prolonged depression in commodity prices. The high cost of hiring expatriate labour raised the operating cost of the mines to the point where these potential resources were bleeding money from the state budget, rather than contributing revenue.

The lessons from the nationalisation period include the following:

  • The mining sector is highly progressive. It is constantly developing and the industry requires ongoing upgrades in technology, legal methodology and management in order to remain competitive.
  • The government did not have the capacity to operate the mines successfully.
  • Governments are better structured for collecting revenue than for generating it.
  • The government exercised control over the mining sector, but this did not benefit the country.

Privatisation

The hard lessons of nationalisation forced the government to rethink the regulation of the mining sector. It sought a solution in a form of extreme privatisation, whereby the mines were transferred into private ownership and the government retained little or no influence over their operation.

The privatisation process began in the 1990s. The incentives for the private sector included (i) the introduction of liberal mining regulations which entrenched tenement ownership and enjoyment, and (ii) generous tax concessions, in the form of both low rates and holidays.

Zambia introduced a new regulatory regime for the industry in 1995 through the Mines and Minerals Act. The new legislation was backed by donors and was extremely favourable to investors; overall, it was a reaction to prolonged underinvestment and suppressed commodity prices.

The main feature of the 1995 act was the concept of a negotiated investment agreement, referred to in the act as a 'development agreement'. This was enacted into law (or assumed the force of law) in order to secure a stable legal and fiscal regime for the industry while placing certain social obligations on the investor. At this stage, the balance of power and benefit in the industry was almost completely with the private sector.

However, at the turn of the 21st century the price of many commodities, including copper and cobalt, began to rise rapidly and spiked in 2008. This led many people within and outside government to question whether it was wise to maintain the 1995 concessions.

Supertax

Following the 2008 spike in commodity prices, the government argued that the fundamental basis of the 1995 concessions no longer existed, as the mining sector was benefiting from a windfall. The government resorted to taxation as a means of changing the situation.

In many countries, one of the functions of taxation is to redistribute resources within the economy, as opposed to merely raising revenue for the government. This is a key objective in countries that rely on certain sectors of the economy to support the national budget.

The main question of taxation versus ownership relates to the point at which a tax system ceases to be a mechanism for redistributing or reallocating economic resources and instead becomes a means of penalising ownership or granting indirect ownership to the state.

It could be argued that any tax on revenue (as opposed to profit) or any tax rate that levies tax at over 50% of profits effectively transforms the tax system into an instrument for penalising ownership or granting indirect ownership to the state. Moreover, a tax on revenue before deduction of a company's business expenses imposes an additional cost on doing business that is beyond the company's control and (in most circumstances) is not directly related to a business venture. This arguably makes the tax penal in nature. Moreover, a tax on revenue (especially where it is coupled with an additional tax on profits) appears to suggest that the state is sharing in both the risk and the success of the taxpaying entity, just like an investor, but without offering initial risk capital.

In 2008 Zambia unilaterally introduced a revenue-based windfall tax under the Mines and Minerals Development Act 2008 (as read with other tax legislation). The mining companies complained that the 2008 act imposed an effective cumulative tax rate of between 70% and 80%(1) on their income. The measures appeared to be a clear attempt at indirect nationalisation, but the government argued that the windfall tax had been introduced in reaction to rising copper prices on the international market. It had evidently decided that the imposition of a supertax was the best way of restructuring the allocation of resources in order to give the state a share of the windfall.

Furthermore, the 2008 act had significant legal effects on the development agreements that had been introduced in 1995. The minister of mines was no longer able to conclude development agreements, while existing agreements were declared "no longer binding on the republic".

The government effectively abandoned the development agreements and introduced new taxes based on revenue and windfall. This resulted in substantially higher tax rates for the industry. Questions arose as to whether mining investors had proprietary rights in the development agreements and whether the government had acted unconstitutionally in unilaterally declaring them void.

Without legislation to clarify the position, the status of development agreements remains unclear. Although the 2008 act stated that the agreements were no longer binding on the state, it appears that it did not expressly or entirely invalidate them. When concluded, the agreements appeared to be binding:

  • on the government and the investor under private contract law;
  • on the government under constitutional law, as they relate to rights that are enshrined in the Constitution and which the government cannot expropriate without paying compensation; and
  • on the government and all governmental agencies under administrative law, as enacted by the 1995 act.

The 2008 act appears to seek to amend the administrative law aspect of the agreements. However, it could be argued that the agreements are still binding on the government under private contract law and constitutional principles.

Reaching equilibrium

Although the 2008 global recession did not immediately affect Zambia (or Africa in general), it finally crept up on the country in the last quarter of 2008. The supertax project implemented under the 2008 act was badly affected and a number of mines either closed or headed into care and maintenance.

Over 10,000 jobs are estimated to have been lost in Zambia as a result of the global economic recession. The government evidently had no plan to anticipate or counteract the recessionary effects and most of its attempts to save the mining industry from collapse were reactionary. These measures included suspending the imposition of the windfall tax regime under the 2008 act.

However, the effect of the recession was short. Its impact on Zambia had lagged behind the initial crisis, and by the time the country began to be severely affected in the second quarter of 2009, commodity prices had started to recover. The balance shifted in favour of government action by the end of 2009, as copper prices were nearing the record highs of the 2008 boom. However, the government had grasped the lesson of the industry's history: that it is possible to kill an industry by glossing over insightful and forward-thinking principles of best practice in regulation.

With the benefit of hindsight, it should have been clear to the government that the main players in implementing international best practice in sector regulation should be the industry, international development finance institutions and the government itself. One writer has described international best practice as a consensus between representatives of these three areas on the necessary ground rules and protection for achieving the private objectives of industry and the public aims of government.(2) Thus, it could be argued that international best practice in any regulatory regime should seek to maximise both the private and public benefits arising from the mining industry by attempting to achieve balance and convergence between private and public goals.

Following the 2008 financial crisis, the government is now exhibiting a greater willingness to engage with industry participants before implementing new regulations. It has disclosed that it will take a more collaborative approach and will not reintroduce the windfall tax, despite improving commodity prices.

Some comfort can be taken from the government's approach. Accommodating public and private interests allows industry stakeholders to achieve discrete but complementary public and private goals through the introduction of legislation that incorporates best practice.

A number of overall lessons can be drawn from Zambia's experience:

  • Best-practice regulation does not mean that one interest group - either government or the private sector - should monopolise benefits; if it does, true equilibrium is unachievable;
  • What may be considered best practice at a particular time in an economic cycle may not be appropriate at another stage of the cycle;
  • Regulations for a particular industry should generally be legally certain, consistent and easy to interpret, while remaining flexible enough to accommodate changing economic circumstances; and
  • Where there is a change in circumstances for which regulation does not make adequate provision, the principles of best practice still hold true. However, stakeholders must strike a new balance to address the change in circumstances through broad consensus, rather than unilateral action, as to do otherwise risks continued dissatisfaction in the industry.

For further information on this topic please contact Charles Mkokweza at Corpus Globe Advocates by telephone (+260 1 235 479), fax (+260 211 238 657) or email (cmkokweza@corpus.co.zm).

Endnotes

(1) Some companies claimed that the effective rate was as high as 95%.

(2) John P Williams, 2008.


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