Today, we see that the dispute between the government and Freeport McMoran over contractual arrangements has mainly focused on unsettled tax concessions.This little piece will analyze why taxation is a hotspot in every dispute between giant mining companies and governments in extractive industries and why there has been so much drama and scandal.

There are two reasons why mining companies including Freeport McMoRan stubbornly try to obtain preferential fiscal treatment and favor a stable tax regime.

First, it is because setting tax terms stability in contractual arrangements is the first step and a legal way for a company to avoid taxes and maximize its profit. Under its contract of work (CoW), Freeport enjoys preferential treatment in several ways, such as tax stability throughout the life of the project until the end of the contract.

The company enjoys a lower percentage of mineral tax such as 1 percent for gold, 3.75 percent for copper, an exemption for export tax, the waiving of import duty on capital goods and other incentives. Such a special package is lower than the percentage in the provision under the Indonesian mineral and coal law.

Secondly, looking specifically at the basis of taxation, many corporations commonly prefer to choose profit-based taxation — mainly through corporate income tax, rather than production-based taxation.

In this scheme, a corporation receives more opportunity and gets an easier way to carry out tax evasion and tax avoidance — mainly through transfer mispricing. In contrast, there is a disadvantage for producing countries because of the lack of monitoring of the volume and record of the company’s actual profits. Although, Freeport’s corporate income tax is 35 percent or higher than the 25 percent required by the Indonesian Income Tax Law, it is still difficult to conclude that the profit based taxation is better for Indonesia rather than production-based taxation.

One of forms of the production-based taxation, which is also challenged strongly by Freeport, is export tax on minerals and other mining products.

The export tax on the extractive industries benefits government in two ways: by making collection easier and giving governments the ability to control the volume, price and quality of commodities exported.

On the other hand, for the companies, the chance to evade taxes through under recording of the real volume and underestimating the quality of ore is narrowed.

In addition, mining companies can manipulate profit reports by increasing costs and undervaluing prices before they shift profits to jurisdictions with lower taxes.

That is why Freeport is unwilling to revisit the fiscal stability terms of its current 30-year CoW. Is Freeport involved in these schemes? We don’t know yet. Some reports have revealed that the mining giant has conduit companies and subsidiaries in tax havens. However, more investigation and more evidence are needed.

The renegotiation of contractual arrangements is a battlefield for both corporations and producing countries. Mining companies will struggle to ensure that they will receive advantageous fiscal terms or if such terms already exist in the contract, they will defend it whatever the condition, including when the government attempts to change its policy in the mining sector.

Intimidation through a legal action and other dirty methods is not taboo for them, for example with bribery, promises to offer initial payments and signature bonuses to the elites in government, and if necessary, using worker layoffs as a tool to put more pressure on the government.

Not only in Indonesia, but also in other developing countries, the government’s attempt to search for a fairer tax regime for mining industries faces pressure from corporations. Worker layoffs have been used as a bargaining tool when the government attempts to renegotiate contractual arrangements and to introduce changes to their tax regimes for mining industries.

For instance, when the Ghana government’s plan to impose a 10 percent tax on windfall revenue in its 2012 budget was dropped due to the threat of multinational companies (MNCs) laying off workers.

Similarly, in Zambia, when government introduced a 25 percent tax on windfall revenue in 2008, it was canceled in 2009 following the threat of MNCs taking legal action and at the same time the copper price being hit by the global financial crisis.

Should Indonesia surrender like Ghana and Zambia? Of course, we should not. So far, we see that the government is still on track to achieve its objectives in this battle: a combination of higher royalties, an export tax and participation in production through public ownership or through joint ventures between state — owned enterprises and the pure private corporation. These demands are still the best option to capture a share of the rents from the extractive sector.

As we know, previously, Indonesia’s attempt to change the contractual terms with Freeport includes a demand that Freeport pay higher royalties, build a smelter and begin paying export tax.

In addition, the government has also asked to increase the stake of the company owned by government or Indonesian citizens to 30 percent from the past 9.36 percent. Freeport agreed to such requests including the provision a US$115 million assurance bond to build smelter. However, the deal fell through when Indonesia offered a new one year export permit with the stricter requirements as required by the new Mineral law.

To the government, however, renegotiation of contractual arrangements is a process of reconciling two different interests. First, the interest of the state to increase its revenue and to ensure that it receives an adequate and fair share of revenue for other development purposes.

And second, the interest of the state to maintain the confidence of the private sector to invest in Indonesia.

However, the interest of the Indonesian people should outweigh the incentives and privileges for the corporation.

Maximizing revenue is crucial to the fulfillment and realization of economic, social and cultural rights and to eradicate poverty. This is also in line with the state’s obligation under the International covenant on economic, social and cultural rights (ICESCR). Meanwhile, the company should understand that their greed and rejection of a fair distribution of rents from mining will affect the deterioration of human rights in Papua and Indonesia.

Freeport’s policy on taxation and its other company business strategy must comply with its obligation as provided by the second pillar of the UN Guideline Principles on Human Rights and Business: The corporate responsibility to respect human rights.


this article was originally published in The Jakarta Post.