69

MINING AND INVESTMENT LAW

IN
PAPUA NEW GUINEA
BY
RT. HON. SIR JULIUS CHAN, K.B.E., M.P.

I. MINING ACTIVITY IN PNG-PAST, PRESENT AND The obvious abundance of gold in PNG has
FUTURE c~eated a great deal of exploration activity
Slnce 1979. The number of companies explorinq
In the sixteenth century the Spanish Captain has risen from 12 in 1979 to 26 in 1985. As
da Alvaro Soavedaro, on a search for the of December 31, 1986, there were 134 current
explorer Ferdinand Magellan, came across the prospecting authorities with another 25 in
main island of New Guinea which he named Isla process.
del Oro (Island of Gold). Since that time
exploration for, and mining of, gold has been The Government of PNG is committed to
pursued by many, culminating in. the encouraging more exploration activity and to
development of major world-class projects in the development of. both large and small scale
the latter part of the 20th century. mi~ing proj~cts in the future. The purpose of
th1S paper 1S to present the policy directions
Though various prospectors have panned for of the government of Papua New Guinea and the
gold and small gold mining projects were legislative and administrativ.e framework
undertaken through the seventeenth and established to encourage investment in mining
eighteenth centuries, it was not until the projects.
1880's when mining became a more concerted
economic venture. Misima and Woodlark Islands 11 POLICY OBJECTIVES
in Milne Bay, Gura-Ackera and Yoada in Oro,
and Lakekamu in Gulf Province and Keveri in Existing mlmng policy in PNG has been
Central Province were all gold producers by fo.rmulated so as to encourage development of
late nineteenth century. It was in the 1920's the country's natural resources on terms and
that corporations began mining in PNG anD with conditions which secure maximum benefits for
the commencement of production at Panguna in the nation and give an appropriate return to
Bougainville in 1972 a new era of mega-project investors.
mining began ..
The government views the development of a
Today there are two large mining projects mineral deposit in the context of the
producing mainly gold and copper. The first, Government's wider social and economic
already mentioned, is Panguna on Bougainville development objectives. These objectives
Island. This project has provided Government include the creation of employment
with $US 475 million in taxes. Ok Tedi is the ~pportuni ties for Papua New Guinea, local
'second large mine development located in 1nfrastructure development and generation of
Western Province. It began production in 1984 ~ax revenues. The objective of the tax regime
with the extraction of the deposit's "qold 1S to collect the maximum tax revenue over the
cap". " operating life of the mine consistent with its
efficient exploitation. In order to achieve
Copper production began in late 1986 and will this, the unique characteristics of the
increase as gold production rapidly tapers resource and the industry must be recognized.
off. A smaller mine at Wau, Morobe Province
is also operational. There are a number of features of the mineral
~esource and the mining industry which were
Further explor~tion has resulted in 1mportant considerations within the context of
delineating other major deposits at Porgera developing specific taxation policy.
(Enga Province). and Lihir (New Ireland) which
together contain an estimated 22 million 1. Ownership
ounces of gold. Plans are underway for the
development of a gold mine on Misima Island The mineral resource is the property of
(Milne Bay) which is expected to produce about the state. With assistance of offshore
2.5 million ounces of gold and 22.5 ounces of expertise and investment funds, the
silver. Lakekamu (Gulf Province) and Tabar resource is transformed into benefits for
(off New Ireland) are in earlier stages of Papua New Guinea i.e. revenue
testing but both are very promising prospects. employment, social infrastructure. '

PACIfiC RIM CONGRESS 81

T1"lEGEOL.OOY.STRUCTURE.M~'lERAl.lSAT1ON GOlOCOAST~
NlOECONOMICSOFTHEPAClFICRlM 26-211.-.oousr19E17
 RT. HON. SIR JULIUS CHAN,' K.B.E., M.P. PAGE NO: 70

2. High Cost Development combined with the geological and economic

risk and the low salvage value of the
Mine development often requires substant mine plant, suggest the need for a more
al up-front capital costs and in PNG it rapid recovery of invested capital than
is often the first modern economic is generally the case in manufacturing
activity which occurs in a previously activity. The great variation in
undeveloped area. As a result, need for profitability requires a flexible regieme
infrastructure Is usually greater, as is that serves the state and the Developer
the requirement for the company to manage during periods of high profitability as
the impact of the development on the well as low.
pe··ple.
Thus the tax env ironment recognizes the
3. Geological Risk underlying philosophy of mineral policy
in Papua New Guinea. The Income Tax Act
Even though the exploration' programme and outlines two separate schemes: one for
feasibility study are carried out with small scale operations and the other for
great thoroughness, it is not possible to large developments carried out under
assure project viability. Unexpected Special Mining Leases.
events associated with geology and
engineering can change the development Special Mining Leases are tenements
costs and these must be accomodated in granted by the State pursuant to Section
tax policy. 71 of the Mining' Act, Chapter No .195. A
Special Mining Lease is only granted
4. Economic Ris~ where there ,has been a large deposit
demonstrated and the issuance of ordinary
Because of the nature of a mining mining tenements would be impractical due
project, the development is subject to to the deposit size, methods of mining
signi fica'nt uncertainty and risk relative and treatment required and the cost of
to other business ventures. Mechanisms preparatory development of the project.
to deal with fluctuations in extraction
costs and metal prices. must be key
considerations included in formulating Ill. TAX PROVISIONS AFFECTING INVESTMENT
mining taxation policy.
There are a number of tax provisions which are
5. Profitability of interest to the potential developer. The
following discussion concerns the application
Viewed over ·a longer term, the Mining of the Income Tax Act to holders of a Special
industry is no more profitable than most Mining Lease. Each lease is treated on a
other business industries. However, some stand-alone basis in the event two or more
operations are very highly profitable for leases are held by the same entity. The major
brief periods. Under these conditions taxes are the royalty tax, corporate income
the government wants a greater share of tax, dividend withholding tax and additional
the excess revenue realized. profits tax.
1. Royalty Tax
6. Mining as an International Industry
Pursuant to Section 104 of the Mining
Most mine development companies have Act, the royalty is collected on the
international operations. Thus, the view F.O.B. revenue earned by the developer on
of the Papup New Guinea Government is the sale or disposition of mine products
that it must offer a stable, competitive or net smelter returns at a rate of
fiscal. regime commensurate with the 1.25%. From the developer's point of
costs, rewards and risks that will view, such a tax is similar to an
attract and keep mining expertise in the operating cost. The tax as now applied
country. On the other hand, the in PNG has minimum detrimental effect
companies must offer the· state a timely because it is relatively small and the
and cost effective development that is tax payment is deductible for computing
competitive . income tax.
7. Conclusion ;2. Corporate Income Tax
These six considerations comQine to Levied pursuant to the Income Tax Act, it
suggest the need for a taxation regime is payable at a rate of 35% of the
which will serve the long term taxable income. .Taxable income is
interests of both the state and defined according to standard accountancy
Developer. The high cost of development, principles. Deductions from income

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PACIFIC RIM CONGRESS 87
THE GEOLOGY, smuCTURE. MINERALISATION
AND ECONOMICS OF THE PACIFIC RIM
GOlD COAST AVSTRAl..lA
2&02ll AUGUST 11181
 -- -------

RT. HON. SIR JULIUS CHAN, K.B.~., M.P. PAGE NO: 71

derived from mine products include a) the development must be in the

operating expenses, interest charges, tax investment recovery period. This
loss from previous years and depreciation. period is defined to continue from
commercial start-up until the
(i) Depreciation Provisions cumulative after-tax cash flow
equals the sum of exploration and
The depreciation expenses, in pre-production capital expenditure.
particular, have been structured to
assist the developer during the b) after tax income, given standard
critical early years after project depreciation provisions, must be
start-up. Since depreciation. is a less than "Target Income". The Tax
non-cash deduction from taxable Act defines target income as 25% of
income, it is an important source of the initial investment, that is, the
cash flow. The Act distinguishes sum of exploration and capital
among several categories of mining expenditures.
capital expenditures and defines the
maximum allowable rate for each. The Both of these conditions must be
major three categories are simultaneously met in order for the
exploration expenditures, mine taxpayer to be eligible. When
development expenditures, and . applicable, the allowable deduction is
expenditure on plant capacity after calculated as the lesser of the amount
commencement of production. necesary to reduce taxable income to
zero, an amount such that after tax
The maximum allowable exploration income is equal to the Target Income or
·expenditure depredation claim is the outstanding sum of undepreciated
the total exploration expenditure exploration and capital expenditure.
divided by five, or the remaining
years of mine life, whichever is In addition the Income Tax Act provides
less. Exploration expenditure from additional flexibility for the
a surrendered .licence is depreciable depreciation of assets. If the taxpayer
at the same rate provided the prefers, he may elect that none of the
depreciation claim is made within 11 previous provisions apply for assets with
years of surrendering the aborted an estimated life of less than fifteen
licence. years. The taxpayer can apply to the
The maximum allowable development Taxation Officer and specify the desired
expenditure depreciation deduction is the depreciation rate. The Chief Collector
total development expenditure divided by Taxes determines the allowable rate. The
ten, or the remaining years of the mine intent of this provision is to allow
life, whichever is less. As with the adequate tax depreciation of short li fe
case of an aborted exploration assets such as motor vehicles.
expenditure, an aborted development
expenditure is depreciable against an (ii) Tax Loss Provisions
operating mine. . Replacement of existing
capital during mine life is included Losses can be canied forward for up
inthe development expenditure pool in the to 7 years but cannot be carried
calculation of depreciation. back. A loss arises whenever qross
revenue minus the sum of royalties,
The above general provisions establish operating costs and interest
the maximum claim available given the payments, is negative.
depreciation of capital expe"ditures for
mining purposes. The maximum claim could 3. Additional Profits Tax
be reduced to the lesser of;
As noted earlier, the mining industry is
the amount necessary to redl:Jce· not any more profitable than most other
taxable income to zero (depreciation industries over the longer term.
claim can not create a tax loss). However, particular operations ar very
profitable, while many operations may be
the residual unclaimed expenditure. profitable for brief periods. The
reasons for these higher levels of
The Act also contains provisions to profitability generally relate to
increase the depreciation claim above the particular characteristics of the ore
standard claim i f mine profitability is body or fortuitous upward swings in metal
low during the critical early years of prices, or both. During these periods of
mine production. To be eligible two high profitability, the State, as the
conditions must be met. owner of, the resource, seeks a share in
the windfall gains. It should be obvious

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PACIFIC RIM CONGRESS 87
THEGEOl.OGY, STRucruRE,MIN£IW.lS'TlON
ANOECONOMlCSOl'TliEP/o.CIFlCRlM
GOlDCOASfAlJ$'1'flAl.lA,
26-29/JJGUST11lll1

Q.., ""(:"D "u."..~"'~

 RT. HON. SIR JULIUS CHAN, K.B.E., M.P. PAGE NO: 72

that in order to have' a lasting, stable payments to both residents and

tax regime it must serve both the non-residents. However, the Company
industry and the State in lean years as receives a tax rebate for dividends oaid
well as good. The Additional Profits Tax to residents.
is intended to address this need. '
This outlines the main features of the
It should be clearly understood that the tax regime to which developers in Papua
Additional Profits Tax does not impose a New. Guinea will be subject. As stated
ceiling on the Developer's profits. before it is 08e based upon providing
Rather, the regime ensures a reasonable incentives for development and ensures
sharing of revenues during' periods of risk sharing. There is, however, other
very high profitability. legislation which impacts on the mine
To operate, the taxpayer must achieve an developer in PNG.
after-tax rate of return of 20% on the
investment before the Additional Profits
Tax applies. In addition, APT taxes are IV. OTHER LEGISLATION AFFECTING MINING
incurred on an after-Corporate Income Tax OPERATIONS
cash-flow. APT cash-flow is defined as
gros,? revenues less operating costs', 1. The Mining Act, Chapter 195.
royalties, exploration expenditure,
development expenditure, interest before Section 102 provides for comoensation in
production start-up, all investment after respect of prospecting or mining on
start-up, a,nd Corporate Income Tax. APT private land. The assessment takes into
liability is defined as the cumulative account damage to the surface and
APT cash flow of the orevious year improvements thereto, including crops and
multiplied by 120% plus the current year economic trees, severance of the land
APT cash flow. The taxpayer can elect froll) other land of the owner, loss of
that the cumulative rate be the U.S. surface rights of way and all
prime rate plus 12%. consequential damage. The landowner-rs
given the right to lodge a claim with the
As long as APT liability remains Mining Warden for assessment of
negative, no APT taxes are incurred. compensation or additiDnal compensation,
This effectively means that no APT taxes and the Warden shall assess the amount to
are payable before achievi~g an after tax be awarded. The Warden I s finding can be
20% rate of return. When APT liability referred to arbitration under the
becomes zero, the tax is incurred at a Arbitration Act if either party is
35% rate on APT cash flow. dissatisfied with the Warden's
assessment. Compensation is not
It should be noted that the APT applies applicable for land that is purchased
to projects under Special Mining Leases outright.
after the end of the Investment Recovery
Period. A negative cash. flow in a 2. Land Act, Chapter No.185.
subsequent year would take the operation
out of the APT position. It would not be Land issues are very sensitive in Papua
payable until APT liability became New Guinea due to traditional land
positive again. The tax is balanced to ownership patterns. Past experience has
avoid any additional burden on what are demonstrated that land disputes between
genuinely marginal projects, to protect rival owners can result in delays in
the investor against unexpected chanqes developing the project. The Department
in international costs of financial of Minerals and Energy suggests that a
capital, and to protect the international Land Investigation be undertaken just
value of the cash flows receivable. prior after completion of the prefeasibility
to liability for APT against exchange study. Many companies have taken the
rate changes. initiative to assist landowners to
resolve disputes, to mark boundaries, and
The calculation of the APT liability also to record land ownership.
incorporates an exchange rate adjustment. In some circumstances a State Lease may
be required. Usually leases issDed under
4. Dividend Withholding Tax the Mining Act are sufficient for most
mining operations. However, if permanent
Dividends which are paid out of retained infrastructure is to be constructed and
earning, after corporate income tax and it will remain after the life of the
after additional profits tax, if mining operation, a company may be asked
applicable, are subject to a divid~d to make application for a State Lease.
withholding tax of 17%. The dividend Usually ~he State will decide whether
withholding tax applies to dividend

PACIfiC RIM CONGRESS 87

THE GEOLOGY, smucruRE,MlNEAAUSArKlN GOLDCOASTALISTJW..l.\
ANOECONOMK:SOFlHE PACIFIC RIM 2&-~AUGUST l1le7
 RT. HON. SIR JULIUS CHAN, K.B.E., M.P. PAGE NO 73

such a Lease is necessary and this will 5. Central Banking Act, Chaper No 138.
usually occur between pre-feasibilit'i and
the end of the feasibity study. The Foreign Exchange regulations issued
pursuant to this Act outline the
If a State Lease is required, the company treatment of such things as the monetary
is subject to a rent payment. It is control provisions, borrowings, insurance
usually five percent (5%) of the and dispatch of securities, and proceeds
unimproved value the land though this can of . export. All inward and outward
be lowered or waived by the Minister transactions' are monitored by the Bank of
after he has considered a report from the Papua New Guinea. Most corporations must
Land Board. maintain a ratio of long-term debt to
equity of 3.1 when obtaining overseas
3. National Investme~t and Development loans.
Authority (NIDA~, Chapter No. 120
NIDA is responsible for the control of V. STATE EQUITY
foreign investment in PNG. All foreign
controlled companies must register with The policy of the government of Papua New
the Authority. However, for exploration Guinea provides for a State option of
purposes a company need only no1;i fy NIDA purchasing up to thirty percent of the equity
of its presence rather than make an in a mining project prior to development.
application for status. Exploration While this is the stated policy, the most the
drilling for minerals is not exempt and State has held is twenty percent in both the
status is required. Bougainville and Ok Tedi projects. An
agreement was signed by relevant parties in
Once a project is in the development 1979 limiting the State's equity share in
stage it is necessary to register with Porgera to a maximum of t~n percent.
NIDA. This involves a detailed project
study. The determination of State equity is made on a
case by case basis during the negotiations
In 'large scale projects, exemptions can with the developer.
be obtained for sUb-contractors. The State equity purchase by the government is
Applications for this exemption must be not a carried interest but is obtained through
made to NIDA. a separate shareholding agreement. In
purchasing its equity the government will
4. Companies Act, Chapter No. 146 always seek to do so on the most favourable
terms that are consis'tent with maintaining an
, All domestic and foreign corporations adequate incentive to investment by private
. doing business in PNG must register with parties. '
the Registrar of Companies. A Papua New
Guinea company must have one resident The government is not concerned with obtaining
director and a resident secretary.' a majority shareholding position. Rather it
A foreign' company must have a resident wants to ensure that Papua New Guineans have
agent. While exploration activities can the opportunity to become investors in. the
be undertaken by both resident and project. The government sees the option as an
non-resident corporations, the case is additional share of net revenues. As well',
much different once the development phase equity ownership gives the government the
is reached. ability to have representatives on the Board
of the Company and thus provides a base of
Section 72 of the Mining Act states that information as well as a direct input into
only a corporation which has its Company decisions on issues of concern to the
pr~ncipal place of business in Papua New Goyernment.
Guinea and which derives its income
exclusively from mining operations, or
activities in connection therewith, can VI. MINING DEVELOPMENT AGREEMENTS
be issued a Special Mining Lease.
These Agreements are negotiated by the
Although the Act allows for the issuance Developer and the State prior to project
of a general mineral lease to any construction. The Agreement addresses issues
"person", authorities will normally such as construction and use of the mine and
require incorporation. Consideration is associated infrastructure, and variations of
now being given to the treatment of the proposed plan.
unincorporated Joint ventures within the
taxation system. With regard to infrastructure, the Agreement
generally states that the Company at its own

PACIFIC RIM CONGRESS 87

THE GEOLOGY. STRUCTURE. MINEAAUSATJON GOLOCQoIST AUSTJlAl,.1.\
ANOECONOMlCSOFTHEPACIFlCRlM ~~AUGUST10!17
 RT. HON. SIR JULIUS CHAN, K.B.E., M.P. " PAGE NO 74

cost, will design, construct, operate and APPENDIX

maintain transport infrastructure facilities,
upgrade existing public transport which may be This Appendix illustrates the application of
required, construct or upgrade accomodation PNG I S tax regime to an hypothetical mine. The
and community -facilities, and power supply examples seek to demonstrate two kev
facilities and construct and install characteristics of the PNG fiscal regime, namely:
telecommunications facili ties. Once
commercial production has begun", the State L i t is a flexible regime where taxes are
wi~l bear the cost of operating the closely related to the profitability level.
infrastructure built for use by the State."
This generally means the public transport 2. the Additional Profit Tax (APT) does not
facilities, roads, accomodation and community impose a ceiling on profits. Rather, the
faciliHes and telecommunications (except for APT regime ensures a more equitable
those located in the mining area or connected distr~bution between the developer and the
thereto). As well, provision is made for the State of the economic rent generated by
purchase of other facilities from the Company. highly profitable projects.

The basic philosophy of this policy is that The examples are based on computer simulations
the State should not bear the cost of any performed with the Department of Minerals and
services over and above what would normally be Energy financial model of the tax reqime.
provided in the absence of development. Thus, Details on assumptions and results are available
the Company pays for infrastructure required upon request.
for the mine and manages the facili ties.
However, the government asks that third Figure 1 shows the responsiveness of taxes to
parties have access to the facilities. With profitability over a mine life. In this
services such as water, sewage and even illustration a gold mine is simulated to
co~mence production in 1989. For the purpose of
electricity, it is a" decision on a case by
case basis as to whether the Company or the thlS example, the price. of gold rises rapidly
government will bear the operating cost. from $US 325/ounce in 1989 to $US 500/ounce in
1996. In 1997, it plummets to $US 200/ounce and
In addition, the Mining Agreement outlines the new investment is required by the mine. In
undertakings regarding rates and duties Figure 1, net revenue is defined as qross
. .
currency provlslons, .
marketlng and other' revenues minus operating costs. Taxes are"made
contracts, NIDA registration provisions up of royalties, Corporate Income Tax (CIT)
training and localization, supply and Dividend Withholding Tax (DWT) and th~
procurement of materials, equipment and Additional Profit Tax (APT). The project is
services, and local business development. eligible for accelerated depreciation in the
first two years of operation. The rising gold
price over the period 1989-1996 increases -net
VII CONCLUSION revenue and the profit sensitive taxes.

Mining is now the largest single contributor The project starts incurring APT in year 5 or"
to Papua New Guinea I s export income, a major operation (1993 on the graph). Net revenues
source of government revenue, and a provider fall steeply in 1997 due to the falling gold
of employment. The role of the mining price. The tax regime reacts immediately; in
industry is expected to become more dominate that year the project realizes positive net
as the number of projects reach advanced income but would not be liable for either CIT or
stages of development. The intent of existinq APT.
mineral policy is to "strike the correct
balance between the needs of the state and the Figure 2 provides more information of the
interests of the private investor. That is application of APT. The graph indicates
the policy is to encourage development o~ effective tax rates over a range of profitable
terms and conditions that realize maximum projects.
benefits for Papua New Guineans whilst
providing an appropriate return to the The X axis of both graphs show an indicator of
investor. The Honourable John Kaputin project profitability, namely the project rate
Minister: for M~nerals and Energy, in a speech of return before taxes. The first qraph shows
to Parllament ln late 1986, succinctly summed effective tax rates as a percentaqe net revenues
up the government I s view when he said:" The' corresponding to di fferent projects before tax
tax regime which ensures mutually beneficial rate of return. For example, a project earning
development both for Papua New Guineans and a 19% before-tax rate of return would face an
foreign investors is regarded as a pace-setter effective royalty tax rate of about 4% of net
for mining regimes throughout the world". revenue, the effective Dividend Withholdinq Tax
(DWT) rate is about 5%, the income tax rate is
slightly over 12% of net revenues; and there is
no additional profit tax.

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PACIFIC RIM CONGRESS 87
THE oeOlOGY STRUCTURE,MINERALlSATION
AND ECONOMICS OFlHE PACIFIC RIM
GOlDCC'AST AUSTFWJA
26 29AUGUST 19l17
 RT. HON. SIR JULIUS CHAN, K.B.E., M.P. PAGE NO: 75

FIGURE I
The second graph shows the net present value of
cash flow to private shareholders, corresponding THE FLEXIBILITY OF THE TAX REGIME
to different rate of returns. The figure shows 400 - . - - - - - - - - - - - - - - - - - - - - - - - ,

that marginal mining projects operate in a

fiscal environment similar to that of any NET REVENUES
private company. They face income taxes, DWT 300
and a small royalty. The APT tax applies only
to more profitable projects, i.e. those with 200
after CH rates of return above 20% (or in the TAXES
vicinity of 30%-35% on a before tax basis). A 200

key point can be seen in the second graph. The

NPV of cash flow available to private
shareholders is increasing even when APT has to 100
be paid. The APT does not impose a ceiling of
funds available for shareholders. The inflexion 50
point of the second' graph indicates that the
return to shareholders increase at a lower rate o-l-==:.:...--,-~--,-~-._~-+~-_,_~-._~
1999 1991 1993 199~ 1997 1999 2001
once APT has been triggered, but it is still r

YEARS
increasing.
FIGURE 2
In other words, a mining project never faces a
100% marginal tax rate even when placed in an TAXES AND PRO FITABILlTY
APT situation. The maximum theoretical marginal 24°/.

tax rate is about 65% assuming, that a company 22°/...

,remit all its dividends to non-residents*. (J)
20'/.
W
:::>
Z
W IBO/ .
>
W
(*) And assuming no outstanding debt, fully a: 16·/0

depreciated costs and an APT situation. I--

w
Z
14·/.

U.
(,) 12'1.

-t. 10%
APT

~
W S·/.
I--
----~-7'-::-..------~
<l
a: 6·/. DWT
x Royalty
4·/.
f'!
2·/.

0-/.
19·/.

PROJECT'S RATE OF RETURN BEFORE TAXES

liD

:J 100
<l
W
a: 90
-t.
!:: ao
~
70
9u.
:r 60

'";) 50
>-
I--
S 40
0
W
30
U.
0
20
>
Q.
Z
10

0
19·/. 23·'. 27·/. 36V.

PROJECTS RATE OF RETURN BEFORE TAXES

PACifIC RIM CONGRESS 81

THE GEOLOGY STRUCTURE MINEAAUSATION GOl.DCC'ASTAVSTRAUA.
ANO ECONOMICS Of THE PACifIC RIM 2ti 29 AUGUST 1S61