NEW MECHANISMS TO EFFECTIVELY USE THE GOVERNMENT TAKE: PERU'S PROJECTS IN LIEU OF TAXES LAW: A NEW MECHANISM TO EFFECTIVELY USE THE GOVERNMENT TAKE

• Jurisdiction: Derecho Internacional

International Mining and Oil & Gas Law, Development, and Investment
(Apr 2015)
CHAPTER 19B
NEW MECHANISMS TO EFFECTIVELY USE THE GOVERNMENT TAKE: PERU'S PROJECTS IN LIEU OF TAXES LAW: A NEW MECHANISM TO EFFECTIVELY USE THE GOVERNMENT TAKE
José Augusto Palma
María Cristina Vlva
General Counsel and Vice President Corporate Affairs
Hochschild Mining
Lima

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JOSÉ AUGUSTO PALMA is Vice President, Legal & Corporate Affairs for Hochschild Mining plc in Lima. He joined Hochschild in July 2006 after a 13-year legal career in the United States, where he was a partner at the law firm of Swidler Berlin, and subsequently Senior Counsel at the World Bank. He also served two years in the Government of Peru. José Augusto has law degrees from Georgetown University and the Universidad Iberoamericana in Mexico and is admitted to practice as a lawyer in Mexico, New York, and the District of Columbia. Prior to his current role, José served as VP Legal at Hochschild.

I. Introduction

Over the last decade, many governments have sought to increase their revenue take from mining and other extractive industries. In Peru, for example government take has increased from substantially over the years to approximately US$492 million in 2013.¹

As a result of this, since 2005, many regional and local governments in Peru have received over US$4 billion² from charges levied on the mining industry. However, because of overall poor institutional capacity and, in some cases, corruption, these authorities have been unable to invest these vast resources in infrastructure projects that can improve the lives of the population. This, in turn, has led many to believe that mining does not contribute enough to the country generally, and specifically to their communities, which is far from reality.

In order to find a solution to this growing problem, in 2008, Peru enacted the "Law of Projects in Lieu of Taxes". This groundbreaking legislation allowed a private entity to invest in public infrastructure projects at the regional and local levels and, in return, obtain a credit that can be used to offset up to 50% of the income tax they would have to pay in future years. The tax credit is valid for ten years and is a negotiable instrument that can be sold to third parties. While implementation of the law was initially slow, it has become an effective way to channel public resources towards much needed infrastructure projects and has created an innovative mechanism for public private partnerships.

This paper will analyze the different aspects of the law, how it works, the amendments that have been made to date to increase its scope and make it more effective, as well as propose a number of ideas to improve further this innovative mechanism that could potentially bridge the infrastructure gap that prevails in Peru.

II. The Evolution of Government Take in Peru

In order to analyze and understand the new mechanism to effectively use the government take in Peru, it is necessary to briefly explain the legal framework of the government take policies. By way of introduction, it is important to note that under Peru's

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Constitution, natural resources within the territory belong to the Nation.³ As such, they constitute part of the national patrimony and their exploitation requires a contribution/compensation to the State.

Since 2011, there are three mineral taxes or royalties levied on the extraction of minerals in Peru: (i) New Mining Royalty;⁴ (ii) Special Tax on Mining⁵ ("IEM"); and the (iii) Special Mining Contribution⁶ ("GEM"). There is also a mining charge ("Canon Minero") which, while not a tax per se, constitutes an integral part of the government-take of the sub-national governments in Peru. This section will describe each of these taxes and contributions.

a. New Mining Royalty ("MR")

This royalty has been defined as the administrative consideration that mining companies (and any other mining concessionaire) pay to the Peruvian State for extracting metallic and non-metallic mineral resources from mining concessions.

This royalty is calculated on the basis of the quarterly operating profit.⁷ The rate of the MR varies from 1% to 7.14%⁸ depending on the operating margin of each mining company. Each company must pay the amount which is the higher of 1% of sales generated during the applicable calendar quarter and the amount resulting from applying the rate of the MR based on its operating profit for the quarter.

The MR is distributed among local and regional governments where the mineral resources are exploited. It is established that the referred contributions shall be used to finance or co-finance investment projects that link the mining activities to the economic and sustainable development of the regions.

The MR is collected by the Peruvian Tax Administration ("SUNAT") ⁹ and administered by the Ministry of Economy and Finance ("MEF"),¹⁰ which must distribute the proceeds of the MR based on the percentages outlined in the following table:

%	Beneficiaries
20	District municipalities where the natural resources are located
20	Provincial municipalities where natural resources are located
40	All the provincial and district municipalities of the department(s) where natural resources are located
15	Regional Governments where exploitation of the natural resource takes place
5	National Universities of the departments where the natural resource is located

b. Special Tax on Mining ("IEM")

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This tax has been defined as the administrative consideration that mining companies (and any other mining concessionaire) must pay to the Peruvian State for extracting metallic mineral resources from mining concessions. Like the MR, the IEM is levied on the operating profit of an operating mining company that exploits metallic minerals. The IEM is calculated on the basis of the quarterly operating profit, on which an effective tax rate of 2% to 5.36%¹¹ is applied. The effective tax rate is determined based on the operating margin of the quarter. In contrast to the MR, a minimum payment has not been established for this tax.

While the funds of the MR are destined to the regional and local governments and public universities of the locations where mining is being conducted, the proceeds of the IEM go to the central government to finance social programs or projects in those jurisdictions that do not benefit from mining royalties or mining canon.

c. Special Mining Contribution (GEM)

The GEM is a contractual form of compensation (that is only binding on the signing of an agreement with the Peruvian Government) that mining company pays for the exploitation of metallic mineral resources. It was created for mining companies that have tax stability agreements and as such could not be subject to the MR and the IEM. In 2011, these companies agreed to "voluntarily" enter into agreements with the State in order to make these contributions, without waiving their tax stability rights.

The GEM is also calculated based on quarterly operating profit, on which an effective tax rate of 3.84% to 8.44%¹² is applied. In contrast to the MR, a minimum payment has not been established for this tax. As is the case with the IEM, the proceeds of the GEM are at the disposal of the central government.

d. Canon Minero.

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The Canon Minero¹³ is not a tax. It is simply a mechanism for distributing the revenues collected by the central government from the income tax paid by mining companies for the economic exploitation of natural resources. Specifically, 50% of the income tax proceeds paid by mining companies is distributed by the central government (through the MEF) to the sub-national governments and the public university of the locality where mining is being conducted,¹⁴ based on the following table:

%	Beneficiaries
10	District municipalities where natural resources are located
25	Provincial municipalities where natural resources are located
40	Provincial and district municipalities of the department(s) where natural resources are located
25	Regional Governments where exploitation of the natural resource takes place
5	Public National Universities of the departments where the natural resource is located

The underlying theoretical objective of the distribution of the mining canon is that by providing resources to the local and regional governments, public investment would be more effective since they are better placed to invest in infrastructure projects that meet the needs of the local population and that have a positive impact by significantly improving

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people's lives. However, poor institutional capacity and, in some cases, corruption make it impossible to meet this objective.¹⁵

III. Projects in Lieu of Taxes ("Obras por Impuestos"): A New Mechanism to Effectively Use the Government Take

a. Its Origins

In order to promote regional and local public investment in infrastructure projects with the participation of the private sector as a catalyst, the Peruvian State promulgated Law 29230 - "Law that Promotes Regional and Local Public Investment with the Participation of the Private Sector" (hereinafter referred to as the "Law")¹⁶ and Regulation,¹⁷ pursuant to which it seeks to incentivize the financing of public works in exchange for future income tax credits. Indeed, instead of paying tax in cash, the mechanism created by the Law, entitles a taxpayer to meet its tax obligations by financing the execution of a public works project in a local municipality or regional government without having to use existing public resources. The system created by the Law is commonly known as the "Law of Projects in Lieu of Taxes" or "Obras por Impuestos" (indistinctively, hereafter referred to as "Works for Tax Credit" or "WTC").

b. Mechanics: Key aspects

i) The Identification and Selection of Projects

Projects eligible for financing under the WTC regime...