12

MINING TAXATION AND ROYALTIES IN SASKATCHEWAN David L. Anderson*

A. Introduction This paper presents a survey of the evolution of the non-petroleum mineral taxation system presently employed by ,the Government of Saskatchewan. Given the province's tendency to rely on mineral-specific levies, Saskatchewan undoubtedly possesses one of the most complex mineral taxation and royalty structures to be found anywhere in Canada. For example, there are at least ten distinct production based levies currently in place although only eight are enforced. 1 ln addition; there are a host of fees and other charges imposed on the remaining stages of the mineral cycle; these shall be ignored throughout the paper. In order to further restrict the scope of the analysis, I shall focus on the uranium and potash industries although cursory attention will be paid to coal, sodium sulphate and base and precious metal activities. Before doing so, I shall briefly discuss two overview issues: the magnitude of mineral related revenues; and the importance of freehold ownership of sub-surface mineral rights in Saskatchewan. From Table i, note that mineral tax collections rose dramatically throughout the 1970's. For instance, in 1971 the industry directly contributed *

1.

Faculty of Administration, University of Regina The author gratefully acknowledges permission received from Donald W. Barnett and Resources Policy allowing me to borrow heavily from a forthcoming, co-authored manuscript entitled "Taxation of Uranium Mining Ventures in Saskatchewan: A Policy Assessinent". This information serves as the basis of the uranium discussion contain. ._ ed within this paper. As will be discussed in Section D, upon the enactment of the Potash Resource Payments Agreement (PRPA), the province agreed not to enforce the Potash Reserve tax and the Potash Producing Tract Tax. In addition, the Potash Crown Royalty should be added to this list since the amount levied is fully credited against PRPA payments. 193

MINING TAXATION AND ROYALTIES IN SASKATCHEWAN

Saskatchewan appropriated between five and eleven per cent of all mineral taxation receipts in Canada. However, the equivalent figure for the 1977 to 1980 period never fell below 41 per cent. 2 Prior to the transfer of resources ownership and management from the federal government to Saskatchewan in 1930, approximately 16 per cent of the province's sub-surface mineral rights had been alienated from the crown. However, through the use of various policy initiatives, the current figure has been reduced to 12.5 per cent. 3 Upon investigation, it is readily determined that only two non-petroleum minerals are produced in non-trivial quantities from freehold land: potash and coal. In recent years a relatively constant 45 per cent of potash production has been obtained from freehold deposits; the corresponding figure for coal is much more volatile due, in part, to the nature of the incentives generated by the Freehold Coal Tax. For example, in 1979, 50 per cent of coal output was produced from freehold land; this figure rose to 64 per cent in 1980 and then declined to 35 per cent in 1982. 4 Although sodium sulphate is located in areas of high freehold ownership, the mineral is extracted from dry lake beds of which the mineral rights have never been alienated from the crown. The province's uranium production is exclusively from crown land and can be expected to remain so since virtually all of the mineral rights in the northern half of the province are held by the Crown. s Throughout the remainder of the paper, I shall proceed as follows. The next section contains a brief discussion of the historical development of the present-day schemes designed to tax coal, sodium sulphate and metallic mineral activities. This is followed by an examination of the development and operating characteristics of the uranium royalty. A somewhat less rigorous assessment of the Potash Resource Payments Agreement follows. The paper then concludes with a presentation of the major findings and recommendations for policy change. 2.

Although this discussion suggests that mineral revenues are relativelY more important to the Government of Saskatchewan than to any of its sister provinces, it does not necessarily follow that mining firms are "unfairlY" treated within the province. If, for example, such revenues are primarily drawn from economic rent, then one cannot infer excessive taxation in a technical sense. Indeed, the substantial revenue collections from potash and, to a lesser extent uranium, may merely represent the simultaneous presence of economic rents and tax regimes which are capable of capturing a higher proportion of the same. In other domains, one or more of these elements may have been absent. Indeed, it will be shown in the subsequent analysis that Saskatchewan has relied rather extensively in recent years, either implicitly or explicitly, on rate-ofreturn schemes which are more sensitive to industry profitability than competing . instruments. 3. This estimate is based on unpublished information obtained from the Saskatchewan Deoartment of Energy and Mines, May 1983. 4. See pp. 4 for details .. 5. The exceptions to this are subsurface rights located on Indian Reserves and approximately 15,000 acres of freehold rights held by Dome Petroleum which represents part of the allotment to the Hudson's Bay Company. 194

Introduction

TABLE 1 Saskatchewan Mining Taxation and Royalty Revenue: 1970/71-1983/84 ($millions, in current year dollars)

Year

1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983a 1984a

Coal

0.45 0.61 0.55 0.59 0.56 0.84 3.80 5.08 7.94 10.17 13.30

Sodium Solphate

0.23 0.54 0.75 0.85 1.70 0.87 1.04 1.39 1.55 1.62 2.10

Potash

2.47 3.24 6.10 10.78 53.34 107.71 82.11 99.77 139.83 161.80 280.26 185.00 60.10 64.10

Uranium

Other

Total

0.91 1.24 0.43 3.77 5.15 14.88 15.02 29.93 28.00 25.80

2.30 1.49 1.51 1.48 1.20 0.58 0.67 0.93 1.85 0.88 2.44 0.88 0.54 0.34

4.77 4.73 7.61 12.94 56.60 110.83 84.65 106.73 148.54 182.40 304.19 225.30 100.43 105.64

Sources: Saskatchewan Department of Finance, Estimates 1983-84, p. 122; Saskatchewan, Saskatchewan Heritage Fund, Annual Report 1981-82, p. 34; and Saskatchewan, Saskatchewan Into the Eighties (Regina: Government of Saskatchewan, 1980), p. 61. (a) Estimated values only; see Saskatchewan, Department of Finance, Estimates 1983/84, p. 122.

$4.8 million to the provincial coffers; ten years later the corresponding figure amounted to $304 million. Even after adjusting for the effects of inflation, this represents more than a twenty fold increase in such revenue. Although part of this increase is undoubtedly attributable to market conditions, much of it is due to the design and imposition of profit-sensitive tax regimes throughout the period under study. A further indication of the dramatic transformation of the Saskatchewan mineral taxation structure during the 1970's can be seen from a perusal of tables 2 and 3. The former illustrates the relative importance of mining levies wit!J. respect to total pro-~incial revenues for each province over the 1970-1980 period. For example, in the early years of this period the mining industry contributed between 0.7 per cent and 1.3 per cent of the Saskatchewan government's total revenue requirements; by 1980 the corresponding figure approached 11 per cent. In contrast, in no other province did the figure reach two per cent of gross general revenue. Another method of expressing the relative importance of non-petroleum mineral revenues to this province is to analyze the distribution of such revenues between all . Canadian provinces. As shown in Table 3, in the 1970 to 1973 interval, 195

MINING TAXATION AND ROYALTIES IN SASKATCHEWAN

TABLE 2 Provincial Mining Revenue as a Percentage of Gross General Revenues, 1970-1980, for Fiscal Year Ending March 31 of Following Year

Total

Year

Nfld. P.E.I.

N.S.

N.B.

Que.

Ont.

Man.

Sask.

Alta.

B.C.

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

0.92 0.92 0.80 0.38 0.44 0.85 1.11 1.39 1.09 1.25 1.86

0.14 0.12 0.11 0.09 0.07 0.12 0.13 0.22 0.24 0.19 0.31

0.08 0.06 0.04 0.24 0.28 0.27 0.09 0.11 0.23 0.70 0.46

0.51 0.33 0.21 0.65 0.32 0.48 0.15 0.34 0.24 0.21 0.34

0.50 0.26 0.29 2.11 1.73 0.64 0.37 0.19 0.31 0.63 0.94

0.73 0.34 0.64 1.32 1.84 0.61 0.71 0.28 0.80 1.70 1.70

0.65 0.53 0.84 0.21 4.50 7.81 5.29 5.97 7.57 7.94 10.87

0.14 0.20 0.19 0.58 0.13 0.14 0.23 0.33 0.33 0.12 0.15

0.51 0.87 0.60 0.33 0.29 0.35 0.52 1.13 1.77 0.89 1.31 0.63 1.48 0.75 . 0.58 0.68 0.80 1.10 0.80 1.17 1.74

Source: Statistics Canada, Provincial Government Finance, Cat. No. 68-207.

B. Coal, Sodium Sulphate and Metallic Minerals Coal The Government of Saskatchewan has taxed freehold coal production since the early 1940's; however, the initial effort was rather modest: 50 cents for each acre under lease for production purposes. 6 This was altered in 1957 when a property tax structure was adopted. 7 More specifically, the assessed value of the coal reserves (AV) was subjected to a levy of eight mills per dollar of AV. However, closer examination reveals this impost to have been a disguised ad valorem production tax since AV was calculated by multiplying the prior year's production by an arbitrarily specified selling price of $0.40/s.1. In 1973, the effective rate of tax was increased by 50 per cent when AV was respecified as follows: AV = 1.5 x Production (t -1) x 0040. 8 The rapid escalation of coal prices in the latter part of the decade encouraged the province to search for a new tax instrument which would be more sensitive to the industry's financial situation. The result was the announcement in 1979 of the Freehold Coal Tax Regulations 9 under which 6.

7. 8. 9.

See RonaldC. Murray, Provincial Mineral Policies: Saskatchewan 1944-75, Working Paper No.6 (Kingston: Centre for Resource Studies, 1978), p. 42. It should be noted that my description of activities in the coal, sodium sulphate and metallic metals area, in the pre-1960 period relies heavily on this document. Saskatchewan, Order in Council 1325/57. Saskatchewan, Order in Council 398/73. The regulations are formally presented in Saskatchewan, Order in Council 1856/79 dated 16 October 1979. For an explanation of the mechanics of the scheme, see Saskatchewan Department of Energy and Mines, "Computational Methods of the Assessor for Assessment of the Mineral Coal Under the Mineral Taxation Act", mimeo, Regina, October 1979. 196

Coal, Sodium Sulpha Ie and Metallic Minerals

TABLE 3 Provincial Mining Revenue, 1970-1980, For Fiscal Year Ending March 31 of Following Year ($millions) (070 of Row Totals in Parenthesis)

Year

Nfld. P.E.I.

N.S.

N.B.

Que.

Ont.

1970

3.3 (4.3) 4.0 (7.3) 3.8 (6.9) ·2.2 (1.9) 3.1 (1.0) 6.9 (2.4)

0.7 0.3 (0.9) . (004) 0.7 0.3 (1.3) (0.5) 0.8 0.2 (1.3) (0.4) 0.7 0.6 (0.6) (0.5) 0.7 2.2 (0.2) (0.7) 1.3 2.6 (0.4) (0.8) 1.6 0.9 (0.7) (0.4) 3.0 1.3 (1.2) (0.5) 3.7 3.0 (1.1) (0.9) 3.3 10.7 (0.7) (2.3) 8.1 5.9 (0.8) (I.1)

22.9

26.5 4.8 3.7 1.6 (34.6) (6.3) (4.8) (2.1) 2.4 14.8 3.4 2.5 (26.9) (4.4) (6.2) (4.5) 18.3 5.3 6.1 2.7 (33.2) (9.6) (11.0) (4.9) 48.2 20.1 11.8 4.2 (41.1) (17.1) (l0.1) (3.6) 154.2 20.6 57.1 4.2 (48.2) (6.4) (17.9) (1.3) 8.1 112.8 64.5 5.3 (22.2) (2.8) (38.8) (1.8) 42.9 11.1 86.0 10.5 (17.8) (4.6) (36.9) (4.4) 4.7 109.0 20.2 24.3 (9.5) (1.8) (42.5) (7.9) 43.7 14.4 157.9 25.5 (12.9) (4.3) (46.7) (7.4) 101.4 22.4 187.8 10.5 (22.2) (4.9) (41.2) (2.3) 163.9 24.6 308.0 15.0 (2204) (3.4) (42.0) (2.0)

1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

(0.0) (0.0) (0.0) (0.0) (0.0) (0.0)

lOA

(4.3) 14.8 (5.8) 13.6 (4.0) 17.1 (3.8) 27.6 (3.8)

(0.0) (0.0) (0.0) (0.0) (0.0)

(004)

16.8 (30.5) 11.8 (21.4) 16.0 (13.6) 26.1 (8.2) 45.7 (15.7) 17.0 (7.1) 43.6 (17.0) 35.1 (10.4) 33.8 (704)

60.6 (8.3)

Man.

Sask.

Alta.

B.C.

Total

12.7 (16.6) 10.1 (18.3) 6.5 (11.8) 13.6 (11.6) 51.8 (16.2) 43.6 (15.0) 60.7 (25.2) 35.4 (13.8) 41.8 (12.3) 68.7 (15.1) 118.8 (16.2)

76.5 (100.0) 55.1 (100.0) 55.4 (100.0) 117.4 (100.0) 319.8 (100.0) 290.9 (100.0) 241.1 (100.0) 256.3 (100.0) 338.8 (100.0) 455.8 (100.0) 732.6 (100.0)

Source: Derived from Statistics Canada, Provincial Government Finance, Cat. No. 68-207.

an attempt was made to develop a theoretically valid property or economic rent tax. 10 Without getting into the complexities of the levy, let it be said that the Freehold Coal Tax is a crude attempt to estimate the value of the ore in the ground and to strike a mill rate which leaves producers indifferent between 'extraction from crown and freehold deposits. The assessed or "fair" value is determined by calculating the net present value (NPV) of the future income stream from the ore body based on the assumption that the financial conditions incurred in the prior year 10. For purposes of this study we shall define economic rent as "a gift of nature whose exploitation yields a return beyond the necessary factor payments to the labour and capital required for its discovery and extraction". This definition is from Mayer W. Bucovetsky and Malcolm Gillis, "The Design of Mineral Tax Policy" in Malcolm Gillis et aI., editors, Taxation and Mining: Nonfuel Minerals in Bolivia and Other Countries (Cambridge, Massachusetts: Ballinger, 1978), p. 97. The theoretical· aspects of property and economic rent taxes is discussed in Albert M. Church; Taxation of Nonrenewable Resources (Lexington, Mass.: Lexington Books, 1981) Chpt.· 3. 197

l....lINING TAXAnON AND ROY AL TIES IN SASKATCHEW AN

will apply, without qualification, for the following ten years. That is, the production, sales and cost data incurred in year t - 1 serves as the basis of the NPV calculation. In addition, the Department of Energy and Mines specifies the necessary discount and cost escalation factors. The resulting NPV or "fair" value (FV) estimate is then multi pled by the mill rate, which is determined annually, to arrive at period t's tax liability. Conceptually, the Freehold Coal Tax has merit; however, it displays serious design flaws. This is attributable to the fact that FV is not calculated until the middle of the tax year and, even worse, the mill rate is not struck until November or December of this same year. Hence, it is virtually impossible to engage in meaningful corporate planning. This situation has led producers to adopt risk minimization strategies: for example, they have switched from freehold to crown lands despite the fact that the expected value of the tax liability on freehold activity is often less than that levied on equivalent production from crown land. The nature of these comments can be observed from the following data: Unofficial Estimates: Saskatchewan Freehold Production % of Total Assessed Value Mill Rate Tax Revenue ($ millions) ($ millions) Production 1979 50.2 9 109 1.0 .267 1.4 1980 64.1 6 1981 47.9 5 167 1.7 108 2.5 1982 34.5 23 Source: Unpublished information, Saskatchewan Department of Energy and Mines.

Year

Due to the extreme uncertainty facing producers and their resulting displeasure, the government has recently announced that the current version of the Freehold Coal Tax will be replaced on 1 January 1984 by a more conventional levy. II From a theoretical perspective, this would be an unfortunate event but it merely reinforces the importance of administrative and micro-design factors in the tax formulation process. In 1944 the province instituted a royalty on the production of coal from crown owned deposits. However, the levy was rather modest: $0.05/s.t. of production., This scheme remained in place until 1978 when it was replaced by an ad valorem production tax levied at a rate of 15 per cent of the value of current year sales revenue. J 2 As illustrated in Table 1, coal tax revenues have increased rather substantially in recent years; however, given the current market for low quality lignite coal, one should not expect real revenues to change in the medium term.

11. Saskatchewan, Department of Energy and Mines, White Paper: Mineral Taxation Act (l083), 20 June 1983, p. 1. 12. Saskatchewan, Order in Council 1579/78. 198

Sodium ,Sulphate

Sodium Sulphate In 1943 the Province issued the Alkali, Mining Regulations, under which a royalty of $0.125/s.t. was applied to all units sold during the fiscal period. 13 Four year later the royalty structure was substantially revised; 14 at this time a two part tax was instituted: a $0.20/s.1. levy on all units selling for less than $7.00/s.1.; and an incremental ad valorem tax ranging from 3.5 per cent on units selling for $7/s.1. to 12 per cent on sales yielding more than $16/s.1. In 1949 the system was again altered as the royalty rate was reduced on all units selling for $10/s.t. or less; and increased on all other sales, reaching a maximum of 25 per cent of incremental sales revenue on product yielding $16/s.1. or more. IS The antecedent of the current scheme was launched in 1955 when an unsophisticated profits tax, levied under the guise of an ad valorem impost, was announced. 16 This levy can be formally portrayed as: TP = R x SV xF, where TP, R, SV and F represent tax payment, rate of tax, sales value, and scale factor, respectively. The most innovative aspect of the scheme was the scale factor (F). It was a pragmatic attempt to estimate an industry average cost structure predicated on the assumption that capital and operating costs were characterized by economies of scale. The explicit structure was formulated as: Annual Production (AP) of Sodium Sulphate - in tons AP 10,000 10,000 AP 15,000 _ 15,000 AP 29,000. _ AP 25,000 20,000 25,000 AP 30,000 _ 35,000 AP 45,000 45,000 AP 55,000 ',55,000 AP 65,000 AP 65,000

Scale Factor (F) 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 1.5

Hence, at output levels of less than 25,000 s.1./yr., the effective tax rate declines below the statutory rate. On the other hand, at an annual output in excess of 65,000/s.1., the effective tax rate is more than double that associated with the lowest output category. Although the official rationale for adopting this approach is unknown, one might surmise that it was intended to capture a uniform proportion of profit from each producer. In the initial version of the impost, the statutory rate was set at 4.5 per cent; this was reduced to 3.9 per cent in 1964 and then increased twelve years later to 10 per cent. 17 13. 14. 15. 16. .17.

Saskatchewan, Order in Council 1357/43. Saskatchewan, Order in Council 1303/47. Saskatchewan, Order in Council 1060/49. Saskatchewan, Order in Council 1394/55 . Authorization for these rates can be found in Saskatchewan, Orders in Council: 1394/55, 1494/64, and 1810/76. 199

MINING TAXATION AND ROYALTIES IN SASKATCHEWAN

Major changes were made to the scheme in 1978. 18 Although the formula remained as before (TP = R x SV x F), the specification of the tax rate was now altered to become an explicit function of the industry's expected profit per unit of production. That is, R = 0.36 x ((P - C)/P) where P represents the Saskatchewan Minerals Corporation posted price for kraft . medium grade sodium sulphate; and C = 0.37 x (0.5 x G + 0.4 x W +. 0.1 x A) where G, W, and A represent the ratio of current to base year costs for natural gas, wages, and other items, respectively. In addition, R may never assume a value of less than 0.04 nor more than 0.15. At the present time, the floor constraint is binding which means that sodium sulphate production is taxed at a rate of four per cent of adjusted sales value. The Alkali royalty payments have been a minor but stable revenue source of provincial revenue for more than 30 years. Although the tax scheme is a rather unsophisticated attempt to both raise a minimum level of revenue and to capture a constant proportion of industry profits, the tax appears to have worked rather well from a pragmatic perspective. Metallic Royalty The origins of the current method of taxing base, precious and radioactive metals from crown land can be traced to the Quartz Mining Regulations (QMR) in 1943. 19 This scheme originally consisted of both a unit and an ad valorem levy yielding a maximum tax rate of two per cent of sales value. In 1945 the system was altered so that the government appropriated the lesser of five per cent of sales value or 10 per cent of mine specific net profits}O After only three years of operation the system was again changed: 2J mines which commenced commercial production prior to 1 January 1947 were to pay the lesser of five per cent sales value or 12 per cent of net profit; ventures established thereafter would be subject to the following progressive income tax structure: Profit Range (PR) ($000'5) 10 PR 100 100 PR 500 500· PR 1,000 PR 1,000

Tax Rate (0/0) 3 5 7 12.5

In 1961 the Quartz Mining Regulations were replaced by the current system as outlined in the Mineral Disposition Regulations (MDR).22 The new scheme, known as the Metallic Royalty, exempted from taxation in-

18. 19. 20. 21. 22.

Saskatchewan, Saskatchewan, Saskatchewan, Saskatchewan, Saskatchewan,

Order Order Order Order Order

in in in in in

Council Council Council Council Council

121/78. 1438/43. 837/45. 171/48. 451/61. 200

MCI allic' RoyaIJ y

come earned in the first three years of operation 23 and thereafter taxed it at a rate of 12.5 per cent. In addition to operating outlays, operators were allowed to make a provision for depreciation and processing expense. The former was set at a variable rate of five per cent to 15 per cent of historic development cost calculated with reference to the straight-line method. The processing allowance was specified at eight per cent of the historic, millrelated capital outlay subject to the constraint that the deduction could I)ot be less than 15 per cent nor more than 65 per cent of operating profit less depreciation. 24 It should be noted that this system, with the exception of the three year tax free "holiday" provision, is in force at the current time. Nevertheless, subsequent changes took place in the method of determination before the above described system was readopted. Shortly after assuming office in 1964, the Thatcher government sought to stimulate the development of the mining industry by reducing the tax on mines commencing commercial production after this date. 25 More specifically, the 12.5 per cent net profit rate was replaced by the following progressive rate structure: Profit Range (PR)

Tax Rate (%) 5 7 9

($OOO's)

25 PR 100 100 PR 500 PR 500

".,." .. ,

On 1 August 1976 the 1964 refinements to the MDR were rescinded along with the three-year tax free holiday of the 1961 scheme. In addition, uranium mining was removed from the list of affected minerals and placed under its own structure. Hence, the current version of the Metallic Royalty is characterized by a 12.5 per cent net profits tax; a five per cent to 15 per cent straight line depreciation system; and an eight per cent processing allowance, the absolute value of which cannot be less than 15 per cent nor more than 65 per cent of oeprating profit less depreciation. At present this conventional mining income tax scheme applies only to the operations of the Hudson Bay Mining and Smelting Company. In recent years the Metallic Royalty has seldom generated more than $1 million in revenues for the Province of Saskatchewan; this situation is unlikely to change over the foreseeable future.

23. More formally, the tax free period terminated after three years of commercial production or after accumulated net profits reached $2 million, whichever came first. 24. For copper, zinc and uranium, the floor level was set at 20 per Cent of operating profit less depreciation. 25. Saskatchewan, Order in Council 1943/64. 201

MINING TAXATION AND ROYALTIES IN SASKATCHEWAN

c.

Saskatchewan Uranium Royalty The Saskatchewan Uranium Royalty (SUR),26 as enacted on 1 August 1976, was said to be based on the following objectives: (i) ensure that a fair share of the excess profits from uranium minerals is captured by the province as owner of the resource; (ii) provide the producers with an adequate rate of return on investment, bearing in mi.nd that mineral exploration is a relatively risky proposition and that market fluctuations have been substantial; (iii) leave marginal production decisions as unaffected as possible; and (iv) guarantee a minimum payment to the province in return for its resources so that resources are not given away just to maintain production, except where the provinces may determine it is in the social interest to do SO.27 From a broader policy perspective, one may speculate that the policymakers were working towards three underlying political objectives. First, was the desire to promote economic activity in northern Saskatchewan. 28 Success in this activity would not only assist the residents of an economically deprived area, 80 per cent of whom are people of Indian ancestry, but it was expected to also help defuse a serious political problem between the native community and the government. To do so would suggest the need to adopt a relatively restrained rent appropriation strategy. Second, was the desire to emerge victorious in the major dispute with the potash industry over the province's right to tax rents and control the nature of the industry's economic development. Although somewhat contentious, it is herein suggested that the policy-makers foresaw that the development of a healthy uranium industry would aid the province in achieving this objective. That is, such an outcome would add credibility to the Blakeney government's claims that their policies were not anti-business and anti-development. Once again, this suggests that it would be in the province's best interests to design a moderate rent extraction agreement. A third broad policy objective was the explicit desire to extract economic rents for the benefit of the owners of the non-renewable resources - the citizens of Saskatchewan. Since significant rents were expected to be generated by the uranium ore bodies of northern Saskatchewan, it is reasonable to assume that the provincial planners wished to design a tax scheme to capture such rents. This approach was consistent with thepolitical ideology of the New Democratic Party and with the then government's ap-

. 26. Saskatchewan, Order in Council 1090/76. It should be noted that this section of the paper borrows heavily from David L. Anderson and Donald W. Barnett, "Taxation of Uranium Mining Ventures in Saskatchewan: A Policy Assessment", Resources Policy (forthcoming). 27. P.G. Halkett, Brief on Uranium Royalty System, Submssion by the Saskatchewan Department of Finance to the Cluff Lake Board of Inquiry, Regina, May 1977, p. 3. 28. For example, see the submissions by the Department of Northern Saskatchewan to the Cluff Lake Board of Inquiry (April 1977) and the Key Lake Board of Inquiry (1980). 202

Saskatchewan Uranium Royalty

proach towards the oil and potash industries. 29 Hence, to not tax uranium rents would have undermined the credibility of its efforts in the above areas where much more was at stake - at least over the next decade. 30 We see that, to some extent, the underlying objectives were in conflict. The first two objectives called for similar policies - a pro-development policy. The third called fora tax regime that not only appropriate rents but, equally important, must be perceived to do so with some zealousness. The existence of this trade-off relat.ionship suggests that the designers might have opted for a scheme that did not begin to aggressively acquire rents until potential investors earned a return somewhat in excess of their risk - adjusted cost of capital. After a brief discussion of the pre-SUR levy, we shall evaluate the Saskatchewan Uranium Royalty to determine if its design characteristics are generally consistent with the direction suggested by the above political economy arguments. The Saskatchewan Metallic Royalty, which was described in the preceding section, was deemed by the NDP government, to be an inappropriate tax system for the uranium industry since it failed to capture a significant proportion of a project's potential economic rent for the public coffers. The outcome of this concern was the development of the Saskatchewan Uranium Royalty (SUR) which took effect on 1 August 1976. The new scheme consists of two major parts: a basic (BR) and a graduated royalty (OR). The first component is straight forward: an ad valorem levy of three per cent of gross sales. Although blatantly inconsistent with the neutrality concept promulgated by advocates of rate-of-return taxation, it assisted the former government in two interrelated ways: it helped provide limited revenue to aid in the provision of social and public goods; and it served the useful political role of allowing the Blakeney government to never be seen to be giving away societies' non-renewable resource base. The graduated royalty component of the tax is of interest from both a theoretical and an empirical perspective; Briefly, it is calculated in the following manner.J! For each prospective mine, an allowable capital investment figure, hence-forth known as the Capital Investment Base (CIB)32 is deter-

29. See John Richards and Larry Pratt, Prairie Capitalism: Power and Influence in the New West (Toronto: McLelland and Stewart, 1979). 30. See Table 1 for information outlining the relative importance of uranium and potash revenues. It should also be noted that oil and gas revenues amounted to $76 million and $603 million in 1975/76 and 1981/82, respectively. (Source: Saskatchewan, Estimates, 1976/77 and 1982/83.) 31. For a thorough explanation of the tax and a detailed example, see P.G. Halkett, Brief on Uranium Royalty System. The example has been reproduced in M.J. Gungh and A.M. Pilling, Federal and Provincial Taxation of the Mining Industry (Toronto: Coopers and Lybrand, 1980); and Paul White, "A Survey of Rate-of-Return Mining Taxation Systems", Rate-of-Return Taxation ofMinerals, Proceedings No. 1 (Kingston, Canada: Centre for Resource Studies, 1978), pp. 41-45. 32. This term has been used by the author in the interest of clarity; technically it should be labelled as "capital investment" but this generates some confusion with respect to the general usage of this term. . 203

MINING TAXATION AND ROYALTIES IN SASKATCHEw.-\N

mined. This figure is the sum of each year's pre-production expenditures and an interest allowance representing the opportunity cost of investment. In essence, the accumulated balance at year-end in the Capital Investment Base is grossed up by the interest factor (IF) and the resulting product represents the opening year balanace of the CIB. 33 Before proceeding, it should be noted that the interest factor (IF) is equal to 110 per cent of the "Chartered Bank Lending Rates Prime Interest Loans" as published by the Bank of Canada. The pre-development expenditures continue to be accumulated and the year-end balance of the CIB "grossed-up" in the previously described manner until it is deemed that the mine has entered commercial production. At this point the Capital Investment Base becomes fixed in value; it now serves as the denominator of the rate-of-return calculation. In addition, this value serves as the opening balance of another important variable in the SUR calculation: the Capital Recovery Bank (CRB). Each year, the CRB is reduced by the Capital Recovery Allownace (CRA) which is equal to the relevant time period's unadjusted operating profit (POP); that is, CRA is that value required to reduce unadjusted operating profit to zero or to reduce CRB to zero - whichever occurs first. If the year-end balance of the CRB is greater than zero, then the amount remaining is "grossed-up" by the interest factor (IF) in an analagous fashion to that described in the derivation of CIB. One more parameter remains to be calculated before we can discuss the nature of the graduated royalty: operating profit (OP). The value of this parameter is equal to the mine's gross sales (GS) less the sum of the following items: production costs (PC); basic royalty (BR); arbitrary expenditure allowances for administration (AEA), marketing (MEA) and working capital (WCA) outlays; operating loss carryforwards (not subject to the gross-up provisions); and the capital recovery allowance (CRA). It is of interest to note that PC, production costs, excludes depreciation and financial charges, and royalty payments, and includes maintenance capital outlays and a provision for the depreciation of social capital. H Once the Capital Recovery Bank (CRB) has been reduced to zero, that is, once all adjusted capital outlays have been recovered by the investor, the graduated royalty scheme is enacted. Determination of the required payment first involves the derivation of the ratio of operating profits (OP) to the capital investment base (CIB); the answer, when expressed in percentage terms, is denoted as ROJ - rate of return on investment. The second stage of the calculation requires the taxpayer to work through the follow-

33. The specific procedure outlined in the initial v~rsion of the regulations fails to provide for appropriate compounding. This point was revealed by Yul Kwon, "A Critique of the Saskathcewan Uranium Royalty in the Light of Neutral Taxation", Materials and . Society, Vol. 6 No.2, 1982, pp. 198-199. 34. The SUR provides for a rate of depreciation on social capital (town site expenditures) of 30 per cent on a declining balance basis. . 204

Saskatchewan Uranium Royalty

ing marginal rate structure: 35 If ROI ratio is - less than 150/0 - 15% and greater but less than 25% - 25% and greater but less than 45% - 45 % and greater

then the graduated royalty payable is: (a) nil (b) 15% of operating profits in this range

(c) 30% of. operating profit in this range plus amount payable in (b) (c) 50% of operating profit in this range plus amount payable in (c) Note that even after full capital cost recovery, the investor is able to earn a tax free rate of return, in nominal terms, of 15% before the graduated royalty (OR) takes effect. It is also of interest to note that the maximum rate of 500/0 only applies to profits associated with a ROI in excess of450/0. The total Saskatchewan Uranium Royalty (SUR) payment is determined by the sum of the base (BR) and the graduated royalty (OR) less, where applicable, a tax credit of 35 per cent of the value of qualified exploration expenses for which no prior claim has been made for Saskatchewan Uranium Royalty purposes. The above presentation provides the information necessary to reveal the essential characteristics of the tax. It is with the exception of certain types of exploration expenditures, project specific; that is, the ring fence is drawn around each mine site regardless of the actual ownership structure of the venture. As a result of this approach, it was necessary to define, in an arbitrary manner, those cost elements that are potentially subject to transfer pricing activity. Hence, after a study of industry norms, the allowable deductions for administrative, marketing, and working capital outlays were set as explicit functions of more readily determined parameters: gross sales, operating expense and the prime rate of interest. Additional assumptions are observable from the above presentation. For instance, each project is assumed to be 100 per cent equity financed since interest and financial changes are not deductible against revenue iIi the determi-nation of operating profit. In addition, the SUR exhibits a rather generolis treatment of depreciation expense. 36 This result is attributable to the fact that, in addition to the immediate expensing of all capital investment before the payment of the graduated royalty, the SUR provides for an annual allowance of 15 per cent of the Capital Investment Base (CIB). Let us now investigate the nature of the Saskatchewan Uranium Royalty in a reciI-world context; this will be carried out by imposing the SUR, and related corporate income taxes, on our proxy version of the Key Lake Mine. 35. This format is taken from M.J. Gungh and A.M. Pilling, Federal and Provihcial TAxation of the Mi'ning Industry, Chpt. 2. It is somewhat more informative than the official version as outlined in the "regulatioris". 36. Yul Kwon, "A Critique of the Saskatchewan Uraniurri Royalty in the Light of Neutral Taxation", pp. 195-] 96; and "Neul raj Taxation and Proviricial Minerals Royalties: The Manitoba Metallic Minerals and Saskatchewan Uranium Royalties", Canadian Public Policy, Vol. IX, No.2, 1983, p. 197. 205

MINING TAXATION AND ROYALTIES IN SASKATCHEWAN

Empirical Results In this section I shall utilize a conventional discounted cash-flow model to calculate the net present value of the cash-flows that will be appropriated by each of the claimants to the project's economic rent. 37 However, before proceeding to describe the results of this exercise a few comments are required on two subjects: the overall tax model and the explicit parameter values associated with the "base case" data set. The Saskatchewan Uranium Royalty (SUR) is one of three main taxes impinging on uranium mining activities in Saskatchewan: the others are the federal and provincial corporate income tax systems. The reader is referred elsewhere for a presentation of these schemes. 38 Nevertheless, it should be noted that, in aggregate, the three tax schemes generate a total maximum marginal tax rate on incremental revenue of 85.3 per cent; 39 when this rate applies, it can be readily shown that incremental revenue would be divided in the ratio of 14.7:27:6.8:51.5 between the equity holders, federal corporate income tax, provincial corporate income tax, and Saskatchewan Uranium royalty. The publicly available data on the Key Lake mine serves as the unit of observation of this study. Since the published data is somewhat incomplete, I cannot claim to be portraying the current economic environment of the operation;40 hence, I have labelled the data set as the "Proxy Key Lake Mine (PKL)" . Nevertheless, PKL is thought to provide reasonable estimates of the potential economic rent generating capacity of the Key Lake ore body. This approach should yield useful public policy information for several reasons. First, this mine is currently under construction, and therefore it should realistically portray the present day financial and technological decision-making environment. In addition, the Key Lake deposit was expected by provincial planners, to generate significant economic rents; 37. The social decision-making criteria employed in this study is similar to that used by Brian W. Mackenzie and Michel Bilodeau, Effects of Taxation on Base Metal Mining (Kingston: Centre for Resource Studies, 1979), p. 43 .. 38. See M.J. Gungh and A.M. Pilling, Federal and Provincial Taxation of the Mining Industry; and E.N. Holland and R.M. Kemp, Canadian Taxation of Mining Income (Toronto: CCH Canadian Ltd., 1978). A useful cashflow format is presented in Brian W. Mackenzie and Michel Bilodeau, Effects of Taxation on Base Metal Mining in Canada, Appendix XIII. The actual corporate income tax system employed is that in place as at 1 July 1981. 39. This rate, which pertains to incremental revenue, not taxable income, is readily found by adding up the various maximum rates: graduated royalty (SUR) - 48.5; basic royalty (SUR) - three percent; federal corporate income tax - 27 per cent; and the Saskatchewan corporate income tax - 6.8 per cent. The sum is 85.3 per cent. 40. The primary sources are the various submissions to the Cluff Lake Board of Inquiry which submitted its Final Report to the Saskatchewan Department of the Environment on 12 January 1981. In addition, interviews were conducted with officials of: the Key Lake Mining Corporation (KLMC); the Saskatchewan Department of Mineral Resources; and the Planning Bureau, Executive Council, Government of Saskatchewan. The latter process generated a significant amount of unpublished material that aided the author in developing a plausible view of the underlying cost structure of the Key Lake mine. . 206

Elllpificul RL'sulis

therefore, it would apper to be an ideal vehicle by which to test the workings of a tax scheme designed to appropriate excess earnings. The basic assumptions employed in the analysis are as follows. The mine is to: be developed over four years at a cost of $508 million; produce 4,500 s.t.lyU 3 0 8 over 15 years; and exhibit operating costs of $4.5/lb U3 0 8 and annual capital maintenance outlays of two per cent of the initial