China Piloting a Sales Tax on Rare Earths, Domestic Miners Hoping it will Become the Norm

Jun. 11, 2014

Government piloting an alternative form of taxation on miners

Recently we reported that China is planning to drop its export tariffs on rare earths and boost the resource tax on miners as early as July 2014, coinciding with the Chinese Ministry of Commerce’s issuance of rare earth export quotas for the second half of this year (see May 23, 2014 Analyst Insight).

We have since been informed by sources in China that the government, via a handful of pilot projects in rare earth producing regions, is exploring the prospect of imposing an ad valorem tax (“value-added tax” or “VAT”) on rare earth sales.

Whether China ultimately opts to boost the current resource tax on its miners, or instead decides to switch to a VAT form of levy on rare earth sales, the action in either case, we believe, will support an increase in rare earth prices.

As explained to Reuters for a June 4, 2014 article, “[we] don’t think the outlook is good for [China’s] WTO appeal and [Chinese officials] realise it”, therefore, “they’re looking at what they need to do in the long-term to take what was once an export tariff and turn it into a tax so the net result is positive”.

China’s miners welcome the prospect of change

For China’s rare earth miners, a VAT imposed on rare earth sales would be much preferred to the current form of resource taxation, which fosters a lot of confusion for companies across the supply chain.

Since the resource tax is levied on the amount of ore mined, and not the value of material produced, the current resource tax imposed on miners yielding near-identical rare earth concentrates can vary significantly if mines are not operating with the same ore grades and/or recovery rates.

These production cost variances translate into rare earth concentrate price discrepancies for separation companies operating in China, and ultimately, into variances in the prices of the separated rare earth products they produce and sell.

Switching to a value-added tax on rare earth sales, as practiced in China’s oil and gas industry, would help level the playing field (to some extent) for China’s rare earth miners and would enable them to exploit lower-grade resources since they would not be taxed for every tonne of ore mined. Moreover, VAT levy would serve to minimize the gap between the production costs of China’s legal and illegal rare earth miners.

The nature of the tax changes ahead will be determined largely by the outcomes of the pilot projects currently underway. Sources told us the projects are being led by China’s Ministry of Finance and State Administration of Taxation in rare earth-endowed regions, such as Ganzhou, located in southern Jiangxi province, and Panzhihua, located in the far south of Sichuan province.

How would value-added tax impact the outlook for rare earth prices?

As with an increase to the existing resource tax rate, we believe the imposition of a VAT in its place will support a rise in rare earth prices proportional to the tax increase. Perhaps more encouragingly, however, an value-added tax will affect the nation’s producers more uniformly than an increased resource tax, thus will support a more consistent price increase across China’s rare earth industry.

It will also increase the transparency of China’s rare earth production costs given that a VAT is calculated directly on the value of material sold (easily calculable), whereas a resource tax is a function of ore type, head-grade, and recovery rate (dynamic metrics).

If value-added taxation is adopted, will China shed its existing resource tax?

Maybe, maybe not. If China’s goal is to boost rare earth prices and dampen price volatility, a VAT-only scheme is seemingly the way to go.

But, if China’s goal is to boost rare earth prices while continuing to make it economically challenging, if not unviable, for producers to exploit low-grade resources, or utilize resources inefficiently, then a resource-tax-only, or combination of resource tax and VAT, will suffice.

Irrespective of what form of taxation is ultimately adopted, the resulting rise in rare earth prices will face the risk of being undermined so long as illegal rare earth production remains rampant in China.

By eliminating the resource tax in its entirety, much of the cost advantage that China’s illegal miners thrive on would also be eliminated, serving to further the nation’s efforts to smash the illegal supply chain.

When might changes to rare earth taxes be introduced?

Our sources told us in late-May that a boost in China’s rare earth resource tax should be expected in July 2014 in conjunction with the Ministry of Industry and Information Technology’s impending announcement of export quota levels for the second half of the year.

However, in light of the VAT pilot projects now underway, we believe July may be premature for any major changes, especially if resource taxation is to be replaced with VAT. Until any modifications are announced and enacted, we do not expect any significant changes to rare earth prices.

Having appealed the WTO’s ruling against its rare earth export restrictions on April 25, 2014, China need not launch any major reforms until the final verdict is delivered sometime prior to July 25, 2014.

 

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