STRATEGIES FOR CAPACITY BUILDING IN MINERAL AUDITING · is used: “Strategies for Capacity...

STRATEGIES FOR CAPACITY BUILDING IN MINERAL AUDITING

A CIRDI DISCUSSION PAPER

May 2017

Prepared by Garth ThomsonAdapted from Needs Assessment and Action Plan for a

Minerals Audit Division, Kenya (Hubert, Le Billon, Robinson & Tychsen, 2016)

© 2017 by the University of British Columbia and Canadian International Resources and Development Institute (CIRDI).

The material in this publication is copyrighted. Quoting, copying, and/or reproducing portions or all of this work is permitted provided the following citation is used: “Strategies for Capacity Building in Mineral Auditing - A CIRDI Discussion Paper”, Canadian International Resources and Development Institute (CIRDI) Report 2017-007.

Program undertaken with the financial support of the Government of Canada provided through Global Affairs Canada.

Programme réalisé avec l’appui financier du gouvernement du Canada agissant par l’entremise d’Affairs mondiales Canada.

Canadian International Resources and Development InstituteVancouver, British Columbia, Canadawww.cirdi.ca [email protected]

3 STRATEGIES FOR CAPACITY BUILDING IN MINERAL AUDITING

FOREWORDIn 2015, the Canadian International Resources and Development Institute (CIRDI) assembled a technical team to conduct a desktop study and field mission to compile a needs assessment and action plan for mineral auditing in Kenya. Funded by Global Affairs Canada, the goal of this project was to support the Government of Kenya’s objectives of generating revenues through the extractive sector to help provide inclusive social programs and services for its citizens. This project was completed in mid-2016.

Throughout the course of this project, the technical team - Don Hubert (Resources for Development Consulting), Philippe Le Billon (University of British Columbia), Laura Robinson (Swale House Partners), and John Tychsen (Geological Survey of Denmark and Greenland) – compiled a wealth of information on international lessons in mineral auditing and step-by-step processes to developing mineral audit capacity in the developing country setting. These findings have been summarized in this discussion paper.

Through this discussion paper, CIRDI aims to share ideas and elicit dialogue on the topic of the fiscal governance of natural resources in developing countries, and in particular the strengthening of capacity to audit natural resource sectors, especially mineral exploration and mining. Establishing mineral audit capacity is an important component in the assessment of regulatory and contractual compliance by mining companies. By improving awareness of the challenges and opportunities facing fiscal governance of the natural resource sector, improved dialogue on these issues can assist countries with emerging mineral sectors in managing revenues from their mineral endowment in ways that will contribute to broad-based economic development and poverty reduction.


TABLE OF CONTENTS

Foreword 3Contents 4Introduction 5International Lessons on Mineral Auditing 5Establishing the Tax Base 7Revenue Analysis and Forecasting 8Artisanal and Small-Scale Mining 9Mineral Audit Best Practices 11Institutional Options 12Mainstream Entity within Ministry of Finance 12Specialized Unit within the Ministry of Finance 12Semi-Autonomous Unit within the Ministry of Mines 12Best Practice 13Building a Mineral Audit Capacity 13Goals and Responsibilities 13Scope and Limits 14Systems and Processes 15Stage 0: Build an Auditable System 16Stage 1. Gather Available Data 17Stage 2. Analytical Procedures 17Stage 3. Conduct Risk Analysis and Develop Audit Plan 18Stage 4. Perform the Substantive Tests 21Stage 5. Reporting 22Conclusion 23References 24


INTRODUCTION

Effectively managing extractive industries and related revenues to stimulate broad-based economic development and poverty reduction is one of the most critical challenges facing resource-wealthy developing countries. Throughout the world, developing countries with emerging mining sectors are faced with the opportunity to manage their natural resource endowments in ways that will achieve long-term development goals.

The developmental record of research-rich countries is mixed. Mineral sector development can be transformative, with the potential to spur improvements in employment, economic growth, infrastructure development, public services, and poverty reduction. However, managing sudden influxes of investment, revenue, and activity can be challenging for developing country governments with limited experience in this area.

This context creates a need for improved mineral sector governance and the accompanying fiscal tools for managing and monitoring mineral rents and revenues, including mineral audit capacity. This is an important component in the assessment of regulatory and contractual compliance by mining companies, notably in terms of public revenues payments, while also ensuring reliable public information on extractive activities.

Regular monitoring, verification, and auditing practices are key to improving the quality of information on activities in extractive sectors; to ensure compliance with relevant legislation, regulations, guidelines and contractual agreements, including the payment of royalties; as well as to reduce the risk of fraud and to increase transparency and accountability in the extractive sectors.

International initiatives aimed at strengthening good governance in the extractive sector, including the African Mining Vision and the Extractive Industries Transparency Initiative (EITI), increasingly call for strengthened national capacity around fiscal controls, including verification and auditing. There is also a growing number of resources to assist countries in capacity building and implementation. This paper builds upon these existing guidance documents to examine strategies for best practice in mineral audit structure and capacity development. This best practice is presented in two parts – a summary of international lessons on mineral auditing, followed by a review of specific steps to building mineral audit capacity in a developing economy.

INTERNATIONAL LESSONS ON MINERAL AUDITING

Strengthening audit capacity in the mineral sector serves to protect the public interest by ensuring that the sector contributes fully to government revenue and the economy, and by ensuring that potential negative consequences of the mining sector are controlled.

A robust audit capacity improves mining sector operations from two sides. It improves the method by which the sector operates by checking the actual implementation of existing policies and procedures, as well as through the direct oversight of key transactions. Audit capacity can also improve the transparency of the sector through the provision of relevant, reliable, timely, and accurate information to key stakeholders.


There is a growing body of guidance both on how to design fiscal systems that are economically efficient and relatively simple to administer, and on specific approaches for strengthening national capacity for tax administration. There are two main sources on tax administration capacity. In 2013, the World Bank published a sourcebook on How to Improve Mining Tax Administration and Collection Frameworks (Gui et al, 2013). This was followed by the 2014 publication of the International Monetary Fund’s handbook on Administering Fiscal Regimes for the Extractive Industries (Calder, 2014). More recently, there have been a series of publications on addressing transfer mispricing in the mining sector including: Guj, Pietro et al. Transfer pricing in mining with a focus on Africa: a reference guide for practitioners; World Bank, 2017; Transfer Pricing Issues in Extractive Industries, Committee of Experts on International Cooperation in Tax Matters, E/C.18/2017/CRP.9, 2017; and Alexandra Readhead, Preventing Tax Base Erosion in Africa: A Regional Study of Transfer Pricing Challenges in the Mining Sector, NRGI, 2016.

Best practice can also be drawn from country-specific approaches and experiences. There are of course lessons from advanced mining countries such as Canada, the United States, Australia, Chile and South Africa. There are also examples of developing countries with very sophisticated and multi-dimensional administration and auditing capacities, such as Botswana and Ghana. The complexity of these systems, however, suggests that they are perhaps less easily adapted to the specific administration and auditing challenges facing developing countries that are starting with minimal existing audit capacity.

Perhaps more relevant are the experiences of countries with nascent mining sectors seeking to put in place a new mineral audit capacity. Here country examples could include Liberia, Mongolia, Sierra Leone, and Zambia.

One of the most celebrated examples of the creation of a mineral audit capacity is the Tanzania Minerals Audit Agency (TMAA). Following major foreign direct investment into large-scale mining in the 1990s, the Government of Tanzania realized that it did not have adequate and effective monitoring of the new mining operations, especially gold production that had grown from US$20 million in 1999 to US$600 million in 2003. In 2003 as a stopgap measure, the government contracted an international assayer company to audit the production of major gold mines and build national capacity in mineral auditing. As high assayer costs left little revenue for the government, an ad hoc government entity, the Gold Audit Program (GAP), was created in 2007, which became TMAA in 2009 as part of the implementation of a new Minerals Policy.

The Tanzanian case holds important lessons for the creation of new capacity in developing countries and these will be explored in detail below. There are also case specific elements that need to be taken into account. Foremost among these is appropriate scale. TMAA provides one model for an audit entity for a country with a large mining sector. In 2010, TMAA had a staff of 65 people and a budget of US$4.3 million – this amounted to about 0.3% of the total value of minerals exported.

TMAA – Revenue-Related Roles and Functions

• Monitor and audit quality and quantity of minerals produced and exported by large-, medium- and small-scale miners; to determine revenue generated to facilitate collection of payable royalty.

• Audit capital investment and operating expenditure of the large- and medium-scale mines for the purpose of gathering taxable information and providing the same to the Tanzania Revenue Authority (TRA) and other relevant authorities.

• Collect, analyze, interpret and disseminate minerals production and exports data for projecting government revenue, planning purposes and decision making in the administration of the mining industry.

• Counteract mineral-smuggling and minerals royalty evasion in collaboration with relevant government authorities.

• Assess values of minerals produced by large-, medium- and small-scale miners to facilitate collection of payable royalty.

• Promote and conduct research and development in the mineral sector that will lead to increased government revenue.


The relative success of the TMAA is also a reflection of the time the institution has had to develop different iterations of policies and laws since inception. This has led to better implementation and improved success potential for the audit agency, and it should be noted that a similar growing period is likely needed for newly minted audit agencies in comparable jurisdictions.

CORE MINERAL AUDIT FUNCTIONS

Taxation of the mineral sector differs in important ways from regular tax administration. According to a recent study, “The complexity of its administration arises chiefly from the complexity of the fiscal instruments typical of the sector. This complexity is in turn driven by the nature of the industry and its economics, such as non-renewability, super-normal profits, high uncertainty and risk, long periods of operation, and price volatility” (Halland et al, 2015).

In seeking to protect government revenues from large and medium-sized mines, the central task of mineral auditing is to verify the tax base against which royalty payments and profit-based taxes are assessed. Revenue expectations can be generated through an analysis of feasibility studies, previous years’ production and sales data, and annual work programs. This data is often best consolidated within a project-specific economic model. Unmet expectations should raise red flags unless the reason for underperformance is well understood. The challenges are different for artisanal and small-scale mining where maximizing revenue potential must be balanced off against the risks of minerals – particularly those easily transported like gold and gemstones – from bypassing the formal system altogether.

Establishing the Tax Base

When assessing the fiscal terms that govern mining projects, there is a common tendency to focus on the percentage rates for the payment of royalties and corporate income tax. This is particularly the case in countries where there is a widespread belief that the government is not reaping adequate rewards in the face of the depletion of their non-renewable assets. In such circumstances, there is often a call to redesign the fiscal system and even renegotiate the terms of existing contracts. A good example of this is the series of fiscal changes that have been implemented and subsequently revoked, in Zambia (Akatu et al, 2015).

However, in many cases where government revenues are not meeting expectations, the reason is not the percentage rates for the payment of royalties and corporate income tax but rather the tax base against which those rates are applied.

Royalties, normally a tax on the value of minerals produced, are commonly thought to be relatively easy to administer. The assessment of a royalty should be no more complicated than multiplying the volume of production by the sale price to determine gross revenue and then applying the relevant percentage rate. However, establishing the tax base against which royalty payments should be made requires the ability to verify the volume and quality of mineral production as well as the fair market price at which the mineral was (or could have been) sold. In some cases, contractual terms also allow the deduction of certain costs to arrive at a “netback” price. Even with a relatively simple fiscal instrument such as a royalty, in the absence of effective verification (at the time of sale or pre-sale verification) and auditing (assessment of the accuracy of the assertion after the fact), there are significant risks of revenue loss. Of these two functions, pre-sale verification is preferable, as it is significantly less expensive than auditing for the resulting reclamation of revenue.


Establishing the Extractive Industries Tax Base

To establish the extractive industries (EI) tax base, relevant government agencies and ministries must have the capacity to verify production quantity, quality and cost, as well as the resource price.

Production quantity and quality: Technical and laboratory equipment and capacity (for example, for mineralogy) are necessary to measure or verify the quantity and quality (ore or crude grade) of production, which, in turn, determines price. Since the sector ministry is often heavily involved in day-to-day physical inspection and regulation of the sector, the responsibility for inspecting ore quantity and quality follows naturally, with sample analysis frequently outsourced to independent laboratories.

Determining the resource price for EI taxation: Relying on the sales price of resources reported by companies for tax assessment may present risks – especially in cases of transfer mispricing between connected parties, whereby resources can be “sold” at a lower price to a connected company in a jurisdiction where the relevant tax is lower. To mitigate this risk, resource prices may be assessed based on prices listed on international exchanges, or by specialized firms that offer pricing services. But the prices of some commodities are not listed on international exchanges; furthermore, resource prices may vary depending on the quality of the resource and transportation costs. In such cases, the assessor may need to rely on the sector ministry to provide market intelligence and monitoring to establish credible free-on-board (FOB) prices.

Determining the production cost relevant to taxation: Assessing production costs requires considerable skill and the cooperation of the sector ministry. Factors to consider include the treatment of stocks, provisions, and reserves; cost recognition; ring-fencing of costs related to non-production-related activities (such that they are excluded from calculations for resource taxes); incorrect categorizing of costs for the purpose of “uplift” (that is, inflating actual costs by a fixed percentage for tax deduction purposes); issues arising from thin capitalization, finance leasing, and currency gains and losses; cost-control rules and mechanisms (as agreed per the legal contract, as well as specific limits on the extent of deductions); and finally, the treatment of cost offsets, such as insurance recoveries, and the extent to which loss may be carried forward. (Halland et al, 2015).

The accurate assessment of corporate income tax is more challenging and at the same time more important. In the absence of significant tax holidays, over the lifetime of a mine corporate income tax would normally be expected to generate far more government revenue than royalty payments. Unlike royalty payments based on the value of production, corporate income tax payments are based on company profit. As a result, these payments are normally deferred in the early years after the start-up of a mine while investment costs are more than offset by company revenues. As with royalty payments, the assessment of corporate income tax requires verification of the volume and quality of production and the fair sale value of the minerals. But since corporate income tax is paid on net revenues, assessment also requires verification of the capital and operating costs associated with production.

An overview of the capacities necessary to establish the base for the assessment of both royalties and profit-based taxes is provided in the Textbox above.

Revenue Analysis and Forecasting

The starting point of effective risk-based mineral auditing is the establishment of expectations for government revenues from specific projects. These expectations can be established through a careful assessment of the project feasibility study in combination with project data from previous years and company expectations as set out in annual work programs. This type of project-level economic analysis is most easily done through the creation of spreadsheet models (Calder, 2014). The model applies the fiscal terms governing a particular project against particular scenarios of production, prices, and costs in order to assess the potential scale and timing of government revenues over the estimated lifecycle of the project.


Governments commonly use economic models for fiscal system design (i.e. the IMF FARI model) and project specific models are often developed in advance of contract negotiations. Economic models can also be used for both project-specific and sector-wide revenue forecasting and budget planning. Economic models can also be used to analyze incoming resource revenues. Actual figures for production, prices, and costs reported by companies for tax purposes can be fed into a model, and the projected revenues compared with actual receipts. If projected and actual payments diverge, themodel should allow for the differences to be identified. Significant differences should prompt detailed follow-up analysis.

ARTISANAL AND SMALL-SCALE MINING

Artisanal and small-scale mining (ASM) describes a diverse sector that comprises a range of mining-related activities that differ in scale and structure. ASM uses a lot of labour and little heavy equipment in comparison to large-scale mining. In addition to scale, a significant distinction between artisanal mining and small-scale mining relates to ownership and control. Small-scale refers to ownership or control by an individual or small group of individuals, where others are paid to work. Artisanal refers to a less formal arrangement where family or organized groups (associations or cooperatives) share in proceeds without a formal notion of purchase of labour. There are estimated to be 30 million artisanal and small-scale miners extracting about thirty mineral commodities in over 70 countries, making this sub-industry a key consideration for sector administrators in most (if not all) developing economies.

Figure 1: Simple Value Chain for ASM

ASM often operates informally and thus, by definition, outside of the purview of the state. The level of formalization and the revenue potential increase considerably along the ASM value chain. A simplified value chain common in the developing country context is provided in Figure 1. ASM operators normally sell their product to dealers/traders operating close to the mine who themselves usually sell their product to traders with a licence to export. The traders will normally sell the product to an international buyer.

The value chain shown above (Figure 1) provides different points for collecting state revenue, whether through royalties, licence fees, and other taxes. Importantly these different state revenues typically increase with the level of formalization. The mining stage within the ASM value chain presents a comparatively smaller opportunity for state revenue collection (besides licence fees) when compared with the export stage.


In general, mining licences require that the licence holder report production quantity, quality and sale price, and pay a royalty based on sale value. This practice is often considered impractical for the ASM sector since ASM miners are often operating without licence. Even in the case of licencing formalization, the licence authorities often do not collect royalties because of: (i) inadequate regulations; (ii) a lack of resources to enforce the legislation given the relative difficulty of assessing production at mine site, (iii) the often very large number of mining groups involved, and (iv) the risk of encouraging information trading and smuggling to avoid royalty payments. In Cameroon, for example, the royalties are collected from the new special small-scale mining (SSM) licences, which mainly are held by Cameroonian “renting out” their licence area to Chinese and Korean companies. In Ethiopia some of the royalties, especially from SSM licences, are collected by the regional authority.

Instead of seeking royalties at ASM mining sites, many governments come to rely on collection at the level of traders or dealers. They are usually required to record the seller’s name and amount for each purchase, and report it quarterly to authorities, or at least when their licence has to be renewed. This information can be used to assess the royalties to be indirectly paid by the traders/dealers, and can also be useful to identify the miners from which royalties could be directly collected.

For the ASM sector to be integrated into processes that focus on formal state revenue and for such integration to effectively contribute to greater transparency in the sector, further ASM formalization should be actively incentivized. The first step is a clear legal and policy framework including addressing ASM in the Mining Law, Mining Regulations, and a national mining policy.

A second crucial step is creating baseline information on the scale and nature of the ASM sector. According to one study, “few governments possess comprehensive data of the whereabouts of resident artisanal operators as well as how many individuals are, in fact, operating as miners.” (Collins & Lawson, 2014) As a result of a lack of adequate knowledge, many interventions in the ASM sector have been ineffective. It is now widely accepted that undertaking a baseline study (country-wide or at least focused on priority regions) is an essential first step. They provide information from which progress can be measured and policies and programmes can be improved. Baseline assessments further inform future efforts and present an opportunity to develop relationships with communities and other stakeholders.

Given the challenges of engaging with tens or even hundreds of thousands of artisanal operators, governments often encourage the formation of associations or cooperatives. This encouragement often takes the form of authorizing access to designated areas and the promise of technical and financial assistance. The formation of cooperatives often depends on support from the government. Some countries have made important progress through World Bank support (i.e. Nigeria, Ghana, Cameroon, Mozambique, Tanzania) but there have been challenges with follow-up support for national authorities after the initial project was completed. In the medium to longer term, however, formalization through associations or cooperatives can not only improve livelihoods, it can also create a sector where royalties and other forms of taxes can be assessed and collected.

Minimizing Corruption

Corrupt practices in the administration of mineral revenues can result in a significant reduction in funds available for government, through either the siphoning off revenues received or the under-collection of revenues. There are three ways of minimizing such risks. Reduce opportunities: Minimizing the discretion of ministers and officers and making decisions on remaining matters transparent. Having a non-tax-assessment agency prepare forecast estimates and follow-up where there are differences with actual revenues received. Having independent internal and/or external auditors undertake random audit checks.

Reduce incentives: Employing key government officers with pay and conditions that encourage a sense of doing “public service.” Seeking to reduce the gap between the salary key officers can earn in government versus industry.

Ensure significant penalties: Having an explicit Code of Ethics that applies to officers dealing with the resources industry. Having an enforcement regime that imposes significant, timely, and evident penalties for behavior that breaches the Code.

Adapted from Guj et al (2013).


MINERAL AUDIT BEST PRACTICES

Assessments of best practices in mineral auditing have yielded a number of major recommendations (Mayorga Alba, 2009), including the following.

Clear Mandates: Responsibilities of the various government entities tasked with the regulation and compliance monitoring of extractive sector operations should be clearly defined. Such clarity, along with coordinated procedures among different government entities, helps avoid regulatory gaps and brings about a level of certainty for extractive companies. It can also help avoid inter-agency conflicts (“turf wars”), reducing information flow and effective governance. Mandated agencies should have an adequate understanding of the extractive sector, including through close coordination between the finance and extractive sector ministries as well as national resource companies.

Commensurate Authority, Resources, and Capabilities: The authority and resources of institutions should be commensurate with their mandate and responsibilities. Core funding should come from a secure budget line. The authority and objectivity of the regulatory agency should be secured through an arms-length relationship with its ministry. The technical capacity of the government agencies entrusted with the regulation and monitoring of compliance is critical for effective, efficient, and sustainable implementation of the government’s policies. There should be continuous capacity building for monitoring and ensuring regulatory compliance to sustain and improve staff competence.Regular Processes: Audits should be carried out at regular intervals to assess production and export volumes, valuation of minerals and hydrocarbons, and the cost of operations. This allows for systematic reporting, as well as the following of trends to more easily detect potential fraud.

Automated Recording: The development of a national cadastre and a national data bank is key to improving transparency, the certainty of rights, the knowledge of the resource base, and the quality and reliability of government revenue estimates. Searchable data banks greatly facilitate reporting, analysis and fraud detection.

Multi-Agency Auditing and Reporting: Redundancy in the form of multiple audits and crosschecked reports can help ensure regulatory capture. Botswana is widely recognized as one of the countries with the best record of mineral revenue collection and management. The government uses a mix of institutions, which helps mobilize technical excellence and provide for inter-agency checks. The main tax assessment and collection function is performed by the Botswana Unified Revenue Service (BURS), and then the Office of the Auditor General audits annual reports. The Department of Mines of the Ministry of Minerals, Energy and Water Resources collects mineral royalties and regulates the industry, while the Director of Geological Survey and the Director of Mines receive audited corporate statements of direct expenditure for exploration and production, respectively. Transparency on extractive sector revenues is complemented by regular reports from the Central Bank. Finally, the Parliament audits the financial reports of the Ministry of Minerals, Energy and Water Resources. In Chile, another country well-recognized for its sound revenue management practices, the Finance Ministry collects payments and regularly publishes information, while its statements are audited by the Auditor General, who in turn reports to the legislature. Additionally, a semi-autonomous commission on copper – the main mineral export – publishes audited information a wide range of variables including production volumes, prices, special taxes and dividends.

Enforcement: It is essential that there is effective enforcement in cases where companies have not complied with their fiscal obligations. Adequate statutory powers are needed to allow for effective enforcement. There should be clear, proportionate, and progressive penalties for non-compliance,


along with clearly defined, timely, equitable and effective dispute resolution procedures. Best practice suggests that auditing and enforcement functions should be separated and that ministerial or agency discretion should be minimized.

INSTITUTIONAL OPTIONS

There is a range of possible institutional settings for revenue assessment and auditing. The three main types are presented below, along with key examples.

Mainstream Entity within Ministry of Finance

Fiscal authorities generally perform revenue collection and auditing, with the assistance of line ministries (mining or petroleum). This is the case for two of the largest mineral producers in Southern Africa. In South Africa, the Finance Ministry’s South Africa Revenue Service collects all tax revenues and royalties from mining companies and deposits them in the national treasury, while also publishing audited annual reports on production volumes, royalties, special taxes, and licence fees. In Zambia the Commissioner-General of Zambia Revenue Authority has the responsibility of administering and collecting the Mineral Royalty, through its Directorate of Large Taxpayer Office.

Specialized Unit within the Ministry of Finance

Units specifically dedicated to mineral auditing have also been set up in a number of countries, especially when the sector involves more technical mineral valuations. One such example is that of the Gold and Diamond Division in Sierra Leone. First conceived as a governmental buying and exporting agency for gold and diamonds, this entity evolved into a mineral valuation and fiscal assessment unit. Its localization within the Ministry of Finance was in part motivated by concerns of collusion in tax avoidance within the Ministry of Mining. It first involved the subcontracting of mineral valuation to an external private agent. Costs, but also allegations of fraud on the part of international assayers and improved capacity of national staff, motivated an end to such subcontracting (GoSL, 2015).

Semi-Autonomous Unit within the Ministry of Mines

The most prominent example of a semi-autonomous entity situated within a Ministry of Mines is the Tanzania Minerals Audit Agency (TMAA). The Ministry of Energy and Minerals deals with broad policy issues and is responsible for the strategic direction and management of TMAA. As stipulated in its establishment orders, on a day-to-day basis, TMAA operates independently from the Ministry of Energy and Minerals (MEM). TMAA has its own budget, Procurement Unit (including Contracting), Finance Department, and Internal Audit Unit. TMAA applies the financial and procurement laws, regulations and guidelines of the Government of Tanzania. While reporting to MEM, TMAA is also supervised by an independent Board of Directors. TMAA provides a good model of an audit entity for a country with a large mining sector. Its main strengths reside in the systematic character of its auditing and the quality of its reporting. Its main challenge has apparently been to see rapid action taken on the problems identified. It also faces difficulties in auditing small- and medium-scale mining ventures due to their number and poor record keeping. TMAA’s relative independence has not been assessed but seems to derive from the quality and competitive pay of its staff, its location outside the Ministry of Energy and Mines compound, and the value given by stakeholders to its public reporting.


Best Practice

Calder (2014) recommends minimizing the number of agencies in charge of extractive industry (EI) taxation and concentrating administration in a specialized unit. This is likely to strengthen revenue collection, since EI revenues come from a small number of very large tax contributors. The specialized unit can be separate or, if there are equally large contributors outside the resource sector, it can be located within a large taxpayer unit (LTU). The aim should be to make the specialized unit a center for administrative excellence (Calder, 2010). In the experience of many developing countries, setting up a special structure to control large taxpayer compliance has generated both increased compliance and more effective tax administration overall. According to Bennon et al (2002), such advances have been achieved through more in-depth knowledge of large taxpayers and their operations, more accurate and timely filing and payment of returns, the earlier detection of noncompliance through oversight of filing and payment obligations, more effective audits performed by better-trained auditors (focused on the EI sector), and reduced stocks of arrears. But to avoid the risk of a centralized revenue management system being used by powerful individuals for private gain, centralization must be backed by transparency and control measures.

Others suggest that in addition to building strong capacity within the Ministry of Finance or Tax Authority, capacity also needs to be built within the relevant sector ministry. “While in most other sectors, tax administration is exclusively the responsibility of the ministry of finance, the strong technical component of EI taxation requires the involvement of the EI sector ministry.” Specifically, “EI taxation requires that the production quantity and quality, the appropriate price, and the production costs be correctly determined—and, for each of these variables, the input of the EI sector ministry is critical” (Halland et al, 2015).

In order to be effective, EI revenue administration requires coordination between EI sector ministries and the ministry of finance (Guj and others 2013). Such coordination often proves difficult in practice. To ensure communication, procedures for the exchange of information must be established, possibly set out in legislation, and included in staff job descriptions. Other possible measures include co-location of the sections of various agencies that are engaged in resource taxation, and staff exchanges or temporary secondments (Calder, 2010).

BUILDING A MINERAL AUDIT CAPACITY

GOALS AND RESPONSIBILITIES

The development of mineral audit capacity must be undertaken with defined goals. The primary goal should be to protect the public financial interest in a nation’s mineral sector. Mineral audit capacity should provide confidence to citizens that the sector is being well managed by scrutinizing mining operations to optimize government revenue and enhancing transparency through credible public reporting.

A mineral audit unit’s mandate should encompass a range of activities, including monitoring the compliance of mineral sector activities with legal and regulatory requirements related to public


revenues; auditing mineral production, expenses, sales and exports from large-scale mining and ASM activity in order to ensure maximum revenue capture; effectively forecasting government revenues from the mineral sector in coordination with other government agencies; and publishing relevant, reliable, timely and accurate information on the mining industry. These activities are detailed later in this chapter.

Country specific needs for mineral audit capacity building vary, and will be tailored based on a country needs assessment, and analysis of the state of the mineral sector, the current mineral audit capacity and substantive existing gaps. However, generally capacity building can be focused in five main areas:

1. Physical Audits of Mineral Production and Exports: Verify the quality and quantity of minerals produced and exported by large-scale operations (at the mine site and/or point of export) in order to facilitate the calculation of royalty payments.

2. Mineral Valuation and Quality Certification: Monitor and audit the value of minerals/gemstones produced and exported by assessing mineral quality (lab audits) and undertaking market price analysis.

3. Verification of Company Expenditures: Monitor and audit capital investment and operating expenditures for large and medium-sized mines in order to verify costs, assess qualification of expenditures for tax exemptions, prevent transfer pricing, and provide inputs to the national revenue authority to ensure payment of appropriate taxes.

4. Revenue Analysis and Forecasting: Collect, analyze, interpret data on minerals production, exports, and market prices in order to assess past and potential future government revenue at the project level and across the sector.

5. Artisanal Production and Mineral Dealers: Monitor and audit the production of minerals produced by small-scale and artisanal operators and sold through dealers in order to begin counteracting royalty evasion and smuggling.

SCOPE AND LIMITS

Audits can be a very effective tool to ensure that companies are accurately remitting tax and royalty payments. An audit, however, is not the first step in meeting the objective of efficiently collecting appropriate government revenue. An audit is a “detective control’ or an activity designed to identify whether inaccuracies or fraud occurred previously. The first step is to create an “auditable system” or a set of mandated disclosures and processes that companies must follow. This allows auditors to compare the actual activity and company reports to the mandates, facilitating clear audit outcomes and increases the likelihood of post-audit revenue recovery.

In the case of natural resource revenue, the governance objective is the efficient collection of appropriate government revenue. There can be uncertainty (and an inherent incentive to under report) in the appropriate reporting and remittance of royalty or tax revenue. There are risks that revenue won’t be collected or that the revenue collected will be less than is appropriate. To control for these risks, there are three categories of internal controls – directive, preventive, and detective.

Directive controls are the laws, policies, regulations, contracts, and government reporting forms. These controls direct the companies on how to submit relevant information to the government. Preventive controls prevent downside risk at the time it occurs. In this case, it could be the threat of an audit, monitored weigh stations as minerals are exported, and/or export control specialists verifying quantity and quality.


Detective controls would include the review of submitted reports and finally, an audit. An audit is one of the most costly controls to implement due to the manpower, specialized capacity, and likelihood of reclamation of revenue. They are also almost always necessary when the risks are this high. They are, however, only effective when directive controls are put in place setting requirements for activity and reporting. An audit is most useful to maintain confidence in the system, but investment by a country in efficient revenue collection systems and low-mid level administrators is more cost effective and exponentially increases the value of an audit, while reducing the cost associated with an audit mechanism.

SYSTEMS AND PROCESSES

Figure 2 sets out a best practice pattern of activity for the annual operations of a Mineral Audit Unit (MAU). These steps are detailed further in the following sub-sections.

Figure 2: The Audit Cycle

1. Gather available data to ensure that the MAU has access to a comprehensive data set with which to inform expectations, identify entities that should report, but are not, and develop the consolidated report.

2. Determine expectations and perform analytical procedures to provide information to other departments in government, inform the development of the audit plan, identify red flags where the national government is at risk for not realizing its full revenue potential and show comparative data to improve understanding of the mineral sector environment under which the licence/permit holders are operating.


3. Conduct a risk analysis and develop an audit plan to identify areas, transactions, and processes that are at risk for fraud, corruption, and undervaluing the payments to the government. Substantive test design requires a practical consideration of the costs of executing the tests and interrupting industry operations.

4. Prepare reports in accordance with the new requirements to facilitate transparency of the sector, facilitate confidence in the management of the sector, and to identify the change (hopefully increase) in collections due to the activities of the MAU.

Stage 0: Build an Auditable System

To improve transparency and to ensure that the mineral sector is fully contributing to the economy, the minerals sector itself must be “auditable.” To be auditable, the sector must have clear mandates for royalty and tax payment calculations, payment transfer, and reporting as well as processes that produce verifiable reports related to the mandates. Systems also need to be put in place to ensure that auditors have access to company records as well as data from other parts of the national government. Finally, particular attention is required to increase the auditability of an ASM sector.

Company Reporting: An essential foundation of an auditable system is high quality of reporting by mining operators and dealers. Improving industry reporting facilitates relevant, reliable, timely and accurate information to the government and the public. Increasing confidence in the effectiveness of the reporting process allows for a reduction in the requirement for and cost of direct oversight that would otherwise be required to ensure appropriate revenue collection.

Mineral sector reporting in developing economies can be highly inconsistent. In some cases it is minimal or non-existent. The importance of development and full implementation of legislated reporting requirements for the effective functioning of the MAU cannot be overstated.

Company Records and Third Party Reports: Official company reports are the foundational data on which the MAU will operate. Analytical procedures and substantive tests also require access to other sources of data including company records and reports from third parties within the national government and beyond. Examples of company records that should be available to auditors would include sales contracts and sales invoices, ore grade reports from independent laboratories, weigh station reports, purchase orders, bills of lading, packing slips, contracts, subcontracts, etc.

A second set of records that auditors may need to access would come from other parts of the national government. Examples of these records would include invoices from the Port Authority for loading bulk shipments or export records from Customs. MOUs may need to be negotiated in order to ensure that the MAU has access to these materials in a timely fashion.

The specific records that could be important for future audits cannot be itemized in the abstract. Rather, they should be identified during a systematic review of the commodity-specific value chain from mine to market.

ASM Sector: As has been noted above, the ASM sector represents specific auditing challenges. Much more foundational work will be required for this sector in order to increase its auditability. The most obvious entry point is to ensure comprehensive reporting by mineral and gemstone dealers, but the challenges of implementation and enforcement should not be underestimated.

Generating reliable data on production quantity and quality from ASM operators is a much bigger challenge. A baseline survey is an obvious place to start, at least in the important regions for ASM production. Continued encouragement/incentivisation of formalization through cooperatives and associations of ASM operators will also create the opportunity to gather consolidated data on production and sales.


Much of the foundational work that may need to be done on the ASM sector falls outside of the scope of the MAU. Specific resources may need to be devoted to the ASM sector, seeking to assess and enhance its broad development potential, rather than narrowly seeking to maximize government revenues through compliance and audit activities. As such, best practice sees the ASM sector gradually integrated into the operations of a Mineral Audit Unit, only as significant progress is made in other areas.

Stage 1. Gather Available Data

The first stage in the audit cycle is gathering the information necessary for the analytical procedures as detailed in Figure 3.

Figure 3: Audit Cycle Stage 1: Gather Available Data

Stage 2. Analytical Procedures

Analytical procedures are an essential component of any audit. They are also the most efficient and cost effective type of test. These procedures include examining relationships among data and assessing the relationships for reasonableness.

Licence/permit holder reports described above are likely to be the largest data set analyzed by an MAU. As described below, the reports will show price data, number of sales, volume of sales, sales by entity, sales by location, exports by location, etc. The data can then be compared to expectations of that same data from independent sources. Independent sources can include mineral models, market forecasts, annual work programs, etc. Given the potential effectiveness and efficiency of analytical procedures, it is optimal to have appropriately set expectations and the highest quality of reporting. It should not be expected that an MAU will begin with optimal levels of either expectations or reporting level and will have to rely on other audit procedures at a greater cost and effort. However, the faster these two components can be implemented, the faster the unit will gain efficiency, effectiveness, and a reputation for excellence.


Setting expectations is a critical component of effective analytical procedures. As these procedures are the most cost effective audit test, it is prudent to allocate appropriate resources to the expectation setting process. The two most useful analytical procedures are the comparison of prior period data to current period data and the comparison of forecasts generated by project-specific economic models to current period data. Additional sources of expected data include feasibility studies and annual work programs. If significant variances exist, the audit plan will be developed to further investigate the reason for the variance. The better the quality of the expectations, the more cost effective the audit.

The two separate steps to the analytical procedure are outlined in Figure 6. The first step is to develop a set of expectations about the factors that contribute to revenue in the national mining sector, including the royalty base factors that are applied to royalty rates and net revenue factors that are applied to corporate tax rates. The second step is to compare expectations with the data contained in quarterly and annual reports and in expenditure statements.

Figure 4: Audit Cycle Stage 2: Develop Expectations and Perform Analytical Procedures

Stage 3. Conduct Risk Analysis and Develop Audit Plan

The third step in the audit cycle is conducting a risk analysis to highlight areas in the mining value chain where the national government is at risk for not realizing its full revenue potential (Figure 5).


Figure 5: Audit Cycle Stage 3: Conduct Risks Analysis and Develop Audit Plan

Figure 6: Risk Matrix (Illustrative only)

ASM permit holders do not pay royalties

Gemstones undervalued at

export

Soda Ash royalties and taxes are not adequately collected

Purity of gold produced in large-scale mines is

underreported

Iron ore production quantity / quality is underreported

Exploration costs are inflated

LIKE

LIH

OO

D

IMPACT


Areas of potential concern would already have been identified through the analytical procedures described above. These can be plotted on a simple risk matrix against likelihood and impact as is shown in Figure 6.

A more detailed example of a risk assessment framework is set out in Figure 7.

Figure 7: Risk Analysis Table (illustrative only)

The next step is to identify control measures that can be implemented to improve the effectiveness of revenue capture as well as the auditability of licence/permit holder reports. Examples are provided in Figure 8.

Figure 8: Control Measures Table (illustrative only)

The final step is a cost-benefit analysis in order to identify cost-effective audit tests that can determine if the reports submitted by licence/permit holders accurately reflect actual operations. The overarching objective is to identify areas where focused control measures audit procedures can maximize revenue capture with minimal audit resources. These inputs allow for the development of an audit strategy and the preparation of a full audit plan.

Risk Title Likelihood (1-10) Impact (1-10) Risk Category

Gemstones are undervalued at export

10Undervaluing of gemstones is

consistent

10Gemstones represent the second-largest

mineral category by royalty

High

Iron ore production quantities are underreported

4Iron ore producers have sufficient measurement procedures, but there is

opportunity for non-compliance

8Iron ore represents the largest mineral

category by volume and royalty

Medium


6It has been reported and

corroborated that exploration costs are consistently inflated

6 Inflated exploration costs reduce net

revenues to which the tax rate is applied and revenue is lost

High


10There is not currently a

requirement for ASM permit holders to pay royalties

2ASM production value is captured in dealer and export royalty payments

Medium

Risk Title Sample Control Measure Sample TestGemstones are

undervalued at exportIssue an export license for gemstones only upon certification of the entire shipment by

laboratory

Confirm quarterly or annual value of gemstones exported per dealer with the lab and compare to

the dealer-submitted [Report Name]

Iron ore production quantites are

underreported

Require a certified weigh station on site that records all shipments off the site and sends

independent records to the MAU

Confirm the weight recorded by the station per quarter to the quarterly license-holder [Report

Name]


Require exploration costs to be audited annually

Physically Observe the capital assets claimed as allowable expenses to determine existence and use a specialist to review for appropriateness


Require increased detail in dealer reports related to ASM activity and promote the development of and reporting by ASM

associations

Perform Analytical Procedures comparing expected and prior year association data to

current year


Stage 4. Perform the Substantive Tests

Perform substantive tests before and after the licence/permit holder reporting to acquire sufficient data to provide the audit opinion required in the second report. A flow chat of these procedures is depicted in Figure 9.

The audit plan would include the acquisition of the following types of substantive procedures:

• Physical Examinations: Examination of the asset to determine or confirm physical characteristics (weight, grade, location, existence, etc.).

• Confirmations: Receipt of third party information (e.g. market rates, dealers, export control).• Documentation Testing: Using internal and external documents to ensure existence and

completeness of transactions and reports (e.g. examining payments between exporters and buyers).

• Re-performance: Retesting ore grade, recalculating average market rate, recalculating the royalty base, reapplying the royalty percentage, etc.

• Inquiries: Obtaining information through inquiries of the licence/permit holders, other parties in the value chain, civil society, and any other party that may be able to provide insight or corroborate other audit evidence.

• Observation: Witnessing activities and processes of the licence/permit holder.

Figure 9: Audit Cycle Stage 4: Perform Audit (illustrative only)


As mentioned above, a priority for an MAU is in-depth verification of royalties due. This crucial element is further detailed as a key example in the textbox below. A similar framework could be developed for the audit of expenses relevant to the assessment of profit-based taxes such as corporate income tax.

Stage 5. Reporting

An MAU annual financial audit cycle should culminate in the publication of an annual report. The goal of this report will be to consolidate the revenue-related results from the mining sector for the year with MAU activities, findings, and recommendations. The annual financial audit cycle (Figure 10) can also facilitate and contribute directly broader mineral sector reporting.

Figure 10: Audit Cycle Stage 5: Prepare and Publish Reports

An MAU will act on findings of individual audits/tests and red flags identified and raised, through informing and linking with appropriate authorities. The MAU’s report will include a reconciliation of the non-compliance issues identified with the actions taken and the results achieved (or not).

Example: Royalty-Specific Testing

Audit procedures related to royalty calculations are often a gap for governing agencies administering natural resource revenue collection. Audit tests should address each component of royalty calculations to ensure accuracy and appropriateness. Additional tests may address the risk of unreported and uncollected royalties.

Tests of Accuracy:• Weight (Physically examine weight on site; confirm weight with independent scale reports; observe the weighing

and recording processes; reweigh the ore after self-reporting is complete - similar to a physical inventory recount).• Price (Send a sample to a lab for analysis and confirmation of grade; compare the price to market price or other

appropriate price).

Tests of Appropriateness:• Price (Confirm that the entity is using the appropriate type of price (market or other) per the regulations.• Royalty Rate (Confirm that the entity is applying the appropriate royalty rate from the schedule).

Tests for Unreported Royalties: prepare a list of mining businesses and make inquiries related to activity; compare purchase reports to sales reports to confirm that every transaction has two parts; inquire with local mining equipment vendors as to clientele.

Tests for Uncollected Royalties: Compare royalties due per the reports to royalty collections per the national revenue agency.


CONCLUSIONIn conclusion, mineral audit capacity is an important component of a functional and effective natural resource governance system. It constitutes a valuable fiscal control that reduces risk associated with mineral revenue collection and loss. A number of guidance documents and examples of successful implementation can guide developing countries in the development of their own mineral audit capacity, and are referenced in the preceding summarization of international best practices in mineral auditing.

The systems and processes for developing mineral auditing capacity are similar across jurisdictions, but must be adapted to varying contexts. Countries with developing mineral economies can look to a variety countries that have gone through potentially similar mineral sector growth, such as Botswana, Ghana, Liberia, Mongolia, Sierra Leone, Zambia, and Tanzania. The experience of these countries represent a variety of mineral commodities, sector scale, and levels of success, and observation of these cases can provide both positive and negative lessons to inform capacity building around fiscal governance of the mineral sector.

The best practice guidelines described in the preceding sections are, however, only effective when directive controls are put in place setting requirements for activity and reporting. They cannot be responsible for covering up other ineffective governance mechanisms and must compliment a broader system with complementary regulations and functions. An audit is most useful to maintain confidence in the system, but investment by a country in efficient revenue collection systems and low-mid level administrators is more cost effective and exponentially increases the value of an audit, while reducing the cost associated with an audit mechanism.

Indeed, investment in mineral auditing capacity must be accompanied by developing or entrenching capacity in complimentary fiscal control mechanisms to ensure strong fiscal governance across the domestic mineral sector. This paper aims to contribute to this end by informing discussion of capacity development in mineral auditing, complimenting associated activities to enhance fiscal controls and strengthen natural resource governance in developing nations.


REFERENCES

Akatu, Patrick; Arnason, Birgir; Mikkelsen, Jan; Goldsworthy, Brenton; and Cecilia Mongrut. 2015. Zambia: Selected Issues, International Monetary Fund Country Report No. 15/153, June 2015.

Benon, Olivier P.; Baer, Katherine; and Juan Toro. 2002. Improving Large Taxpayers’ Compliance: A Review of Country Experience. International Monetary Fund, Occasional Paper No. 215.

Calder, Jack. 2010. Resource Tax Administration: Functions, Processes and Institutions,” in Phillip Daniel, Michael Keen and Charles McPherson (eds.) The Taxation of Petroleum and Minerals: Principles, Problems, and Practice. (New York: Routledge).

Calder, Jack. 2014. Administering Fiscal Regimes for the Extractive Industries: A Handbook. Washington, DC: International Monetary Fund, p. 95.

Colllins, Nina; and Lynda Lawson,. 2014. Investigating Approaches to Working with Artisanal and Small-scale Miners: A Compendium of Strategies and Reports from the Field. International Mining for Development Center, p. 12.

Guj, Pietro; Bocoum, Boubacar; Limerick, James; Meaton, Murray; and Bryan Maybee. 2013. How to Improve Mining Tax Administration and Collection Frameworks: A Sourcebook. Washington, DC: World Bank, p. 98.

Government of Sierra Leone (GoSL). (2015) Structure of the Ministry. Ministry of Mines and Mineral Resources. http://slminerals.org/structure-of-the-ministry/.

Halland, Havard; Lokanc, Martin; Nair, Arvind; Kannan, Sridar Padmanabhan. 2015. The Extractive Industries Sector: Essentials for Economists, Public Finance Professionals, and Policy Makers. Washington, DC: World Bank, p. 76.

Hubert, Don; Le Billon, Philippe; Tychsen, John; Robinson, Laura. 2016. Needs Assessment and Action Plan for a Minerals Audit Division, Kenya. Unpublished advisory report. Canadian International Resources and Development Institute.

Mayorga Alba, Eleodoro (2009) Extractive Industries Value Chain: A comprehensive integrated approach to developing extractive industries; Calder, M. J. (2014). Administering Fiscal Regimes for Extractive Industries: A Handbook. International Monetary Fund.

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