## _tnm1601 - Executive Summary

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### Executive overview
- FARI (Fiscal Analysis of Resource Industries) is an Excel-based discounted cash flow (DCF), project-level tool used for:
  - fiscal regime design and evaluation;
  - calibration of fiscal parameters;
  - sensitivity analysis and international comparisons;
  - revenue forecasting, revenue management analysis (including quantification of fiscal rules);
  - tax gap analysis.
- Model assumptions:
  - full efficiency of revenue collection;
  - no international tax planning;
  - no opportunity to deduct costs from one project against revenues from another in the absence of a well-defined fiscal boundary (ring-fence).

### I. Background: why project-level analysis is needed
- Distinguishing project characteristics: high sunk costs, long production periods, pervasive uncertainty, resource exhaustibility.
- Fiscal regimes for extractive industries (EI) diverge from general tax systems and vary in structure, choice of instruments, rates, and interactions among instruments.
- Interactions among fiscal instruments and project profitability can produce effects not inferable from headline tax parameters alone; fiscal instruments must be evaluated as a package.
- FARI quantifies fiscal-package interactions (for example, the rate at which capital costs can be deducted for CIT purposes).

### Box 1: Defining the EI fiscal regime (summary)
- The EI fiscal regime is the combined system of tax and non-tax instruments used to raise government revenue from natural resource extraction, including:
  - conventional instruments (royalty, CIT);
  - contractual schemes (production-sharing, risk service contracts);
  - lump sum payments (signature bonus), production bonuses, state participation;
  - taxes/fees/levies that add to input costs;
  - mandated non-revenue requirements (domestic supply at below export parity, equity acquisition by citizens).
- Regimes may be project-specific (contractual) or sector-specific (uniform).

### II. Fiscal modeling of resource projects
- FARI evaluates the full lifecycle: exploration → development → production → decommissioning/closure.
- Purpose: estimate government’s share of a project’s total pre-tax net cash flows (economic rent when discounted at the minimum return to capital) and analyze interactions among fiscal parameters.
- DCF approach:
  - Inputs: fiscal parameters, annual project costs and production volumes, economic assumptions (prices, inflation, interest and discount rates), financing assumptions.
  - Calculations: project net cash flows before tax; fiscal payments per regime parameters; total government revenue from the project.
  - Outputs: indicators for neutrality, revenue raising capacity, time profile of government revenue, progressivity; standardized economic indicators (AETR, METR, post-tax IRR).

### Project lifecycle and timing
- Phases and timing examples:
  - Exploration: seismic-to-drilling can take between 3 to 5 years; appraisal can take between 4 to 10 years (sometimes longer) from discovery to commercial production.
  - Development:
    - Mines: usually lasts between 2 to 5 years.
    - Petroleum: onshore ~about a year; offshore may take up to seven years depending on size.
  - Production: can span over 20 years depending on reserves.
  - Closure/decommissioning: site restoration and rehabilitation can be very expensive; companies may set aside funds once a certain percentage of reserves has been depleted.

### III. FARI: model inputs and project data
- Project definition: all upstream activities required to commercially develop and exploit a mineral deposit or petroleum field (exploration through closure/decommissioning).
- Inputs entered in predefined templates: production volumes at valuation point, cost categories by phase (exploration, development, production, decommissioning).
- Production profile: stylized models assume a single commodity produced; FARI can be adapted for multiple products in TA work.
- Cost profile: classification and fiscal treatment of costs by phase is central (depreciation schedules, deduction rules, by-product credits).
- Conventions in examples: "$mm const means millions of dollars at constant prices; 000 ounces means thousand ounces; Mbpd means thousand barrels per day; MMBbl means million barrels."

### Valuation point(s) for fiscal purposes (Box 2)
- The valuation point determines taxable bases; there may be multiple valuation points corresponding to different instruments (e.g., royalties at wellhead vs CIT at point of sale).
- Net-back pricing for royalties and tax bases:
  - Net-back price = value at point of first sale (arm’s length) minus estimated costs of moving product from wellhead/mine mouth to point of sale.
  - Model allows deduction of transportation, refining, processing costs incurred beyond fiscal point to determine taxable income and royalty bases.
- Cost classification examples:
  - Capital: development costs (tangibles/intangibles), replacement capital.
  - Tangible development expenditures: subject to depreciation (straight line, units of production, declining balance).
  - Intangible development expenditures: often expensed as incurred or amortized by units of production.
  - Replacement capital: likely depreciated for tax purposes.
  - Operating costs: extraction-related; processing/refining/beneficiation; transportation before fiscal point; other operating costs (selling, general, administrative).
- Economic assumptions:
  - Prices: user may choose one constant price path in real terms.
  - Inflation: model uses one inflation rate uniformly for prices and costs; example assumes %2.0%.
  - Interest rate: real interest rate used for financing-charge calculations (example real interest rate: %5.0%).
  - Discount rates: results expressed in NPV terms in real terms; example discount rates: government %10.0%, contractor %12.5%.
- Financing assumptions (simplified; pertain to debt-financed portion):
  - Percent of development costs borrowed: %70%
  - Repayment period (beginning production): years5
  - Real interest rate: %5.0%
  - Thin capitalization rules must be taken into account where applicable.

### Box 3: Estimating the investor’s cost of capital
- WACC formula:
  - WACC = w_d r_d (1–t) + w_e r_e
- Cost components:
  - r_d: yield to maturity on the company’s debt; pre-tax cost adjusted for tax shield.
  - r_e: estimated via CAPM, multifactor or build-up models.
- Practical caveats: resource projects may have multiple debt types, grace periods, capitalized vs paid interest; technical note simplifies to focus on interest expense in taxable income.

### Illustrative project outcomes (using assumed inputs and discount rate of %10%)
- Gold mine (pre-tax):
  - Real IRR: 41 percent
  - Project pre-tax cash flows NPV10: 508 (USD million)
  - Nominal IRR: 43.5%
  - Project pre-tax cash flows NPV10 (nominal): 602 (USD million)
- Petroleum project (pre-tax):
  - Real IRR: 35.5 percent
  - Project pre-tax cash flows NPV10 (constant prices): 1,021 (USD million)
  - Nominal IRR: 38.2%
  - Project pre-tax cash flows NPV10 (nominal): 1,200 (USD million)
- Viability criteria in FARI:
  - Project considered viable when post-tax NPV, using the assumed hurdle rate required by the investor, is not negative or post-tax IRR ≥ investor’s discount rate.

### Mining fiscal regimes (Box 3 examples and modeled results)
- Modeled base-case mining fiscal regime (Regime 1):
  - Royalty on sales value: %5 percent (assessed at mine gate)
  - Corporate Income Tax (CIT) rate: %30 percent
  - State participation (free equity): %10 percent
  - Dividend withholding tax: %15 percent
- Alternative regimes:
  - Regime 2: adds a %20 percent surcharge on cash flows (SCF) calculated after CIT.
  - Regime 3: adds a %20 percent Resource Rent Tax (RRT) payable after a nominal rate of return of %10 percent is achieved (on cumulative results net of CIT payment).
- Royalty base example:
  - NetRevenue_t = (MarketPrice x Production)_t – Trans&Proc_t (royalty deductible from income tax base).
- CIT base example:
  - CITbase_t = NetRevenue_t – Royalty_t – Opex_t – CapexDepr_t – Interest_t + LossCarryForward_{t–1}
- Additional profit taxes:
  - SCF: taxed when cumulative project net cash flows become positive; modeled to reset positive end-year balance to zero after taxation.
  - RRT: negative balance carried forward with an uplift (minimum required return) before taxable once negative cash flows are offset.
- Mining regime fiscal results (DATA IN MILLION USD (MARKET PRICES)):
  - Regime 1 (Royalty/CIT):
    - Royalty $mm nominal:133
    - Income Tax $mm nominal:344
    - State participation $mm nominal:806
    - Dividend withholding tax $mm nominal:108
    - Total government revenue $mm nominal:666
  - Regime 2 (Royalty/CIT + SCF):
    - Royalty $mm nominal:133
    - Income Tax $mm nominal:344
    - Additional profits tax (SCF) $mm nominal:169
    - State participation $mm nominal:365
    - Dividend withholding tax $mm nominal:86
    - Total government revenue $mm nominal:795
  - Regime 3 (Royalty/CIT + RRT):
    - Royalty $mm nominal:133
    - Income Tax $mm nominal:344
    - Additional profits tax (RRT) $mm nominal:154
    - State participation $mm nominal:806
    - Dividend withholding tax $mm nominal:88
    - Total government revenue $mm nominal:784

### Petroleum fiscal regimes: PSC vs tax/royalty (examples)
- Key distinction:
  - PSC: government retains ownership; contractor recovers costs via “cost petroleum” and receives “profit petroleum” shared with government.
  - Tax/royalty: investor granted ownership at extraction and pays royalty and taxes.
- Illustrative one-barrel equivalence (USD100):
  - Tax/royalty: Government receives USD36 via USD10 royalty, USD12 income tax, USD14 additional profit tax.
  - PSC: Government receives USD36 via USD30 profit oil and USD6 income tax.
- PSC mechanisms modeled:
  - DROP (production-rate tiers) and R-Factor (cumulative payback) sharing rules.
- Example PSC parameters:
  - Production bonus at start of production: $mm 50
  - Cost recovery ceiling: %80 (Regimes 1 and 2), %100 (Royalty/Tax regime 3)
  - Investment uplift (where applicable): %15 (Regime 2)
  - Profit petroleum DROP tranches (Mbpd): 15, 30, 45, 60 with government shares %s 40, 50, 60, 65 and %75 for >60
  - R-Factor tiers: thresholds 1.00, 1.50, 2.00, 2.50 with government shares % 40, 50, 60, 65 and %75 beyond 2.5
  - Corporate Income Tax rate in PSC examples: %20 (PSC regimes) and %30 (Royalty/Tax regime)
  - Dividend Withholding Tax: %5
  - State-owned company (SOC) participation: %10
- PSC regime fiscal results (Table 16, DATA IN MILLION USD (MARKET PRICES)):
  - PSC (DROP):
    - Production bonus $mm nominal:50
    - Profit petroleum $mm nominal:1,215
    - Corporate income tax $mm nominal:201
    - Dividend withholding tax $mm nominal:38
    - State participation $mm nominal:142
    - Total government revenue $mm nominal:1,646
  - PSC (R-Factor):
    - Production bonus $mm nominal:50
    - Profit petroleum $mm nominal:1,293
    - Corporate income tax $mm nominal:187
    - Dividend withholding tax $mm nominal:35
    - State participation $mm nominal:135
    - Total government revenue $mm nominal:1,699
  - Royalty/Tax (comparison):
    - Production bonus $mm nominal:50
    - Royalty $mm nominal:1,140
    - Corporate income tax $mm nominal:322
    - Dividend withholding tax $mm nominal:35
    - State participation $mm nominal:150
    - Total government revenue $mm nominal:1,697

### Time profile of government revenue and policy implications
- Timing characteristics:
  - Production and indirect taxes (royalty, bonuses) raise revenue early in project life.
  - Profit-related instruments (CIT, SCF, RRT/Rent taxes) generate revenue later, after investor cost recovery and required returns.
- Policy trade-offs:
  - Royalties: early, stable receipts but limited responsiveness to higher profitability.
  - Rent-related taxes (RRT/SCF): later receipts but more responsive to profitability; choice affects risk sharing between government and investor.
- FARI evaluation metrics used in fiscal regime design and TA:
  - Investor perspective indicators: post-tax NPV, post-tax IRR, payback period, break-even price.
  - Indicators refer to provider of total funds outlaid (equity, debt, retained earnings) — i.e., post-tax, pre-finance results; debt considered only in CIT calculations to show interest effect on tax base.

### Box 4: Investor post-tax profitability indicators
- Post-tax NCF formula:
  - Post-tax NCF_t = Pre-tax NCF_t – Royalty_t – Taxes_t
- Post-tax NPV formula:
  - Post-tax NPV = ∑_{t=0}^{n} Post-tax NCF_t / (1 + r)^t
- Post-tax IRR: discount rate at which NPV = 0; calculated both for total funds and return to equity (by netting lender cash flow).
- Payback period: time when cumulative cash inflows recover cumulative cash outflows; can be undiscounted/discounted and leveraged/unleveraged.
- Model limitations and caveats:
  - Assumes full efficiency in revenue assessment and collection;
  - Assumes full project ring-fence;
  - Assumes no losses through international tax planning for CIT calculations.
- Model adaptability: can be modified to relax assumptions; used in TA for EMV and stochastic probability analysis.

### Box 1: Reconciling FARI with companies’ financial statements
- Challenge: FARI is project-level; companies report consolidated financial statements across portfolios and vertical integration.
- Reconciliation approach:
  - Compare FARI investor net cash flows to Free Cash Flow to the Firm (FCFF) from company financial statements.
- FCFF calculation highlights:
  - Start with net income (income statement);
  - Add non-cash charges (depreciation), add after-tax interest expense, subtract capital expenditures and working capital investment to arrive at FCFF.
- In theory, FCFF from an upstream company operating only one project should reconcile with FARI post-tax cash flows over project life.

*Source: Executive Summary of the FAD FARI methodology technical note.*

### Executive Summary

### _tnm1601 - Executive Summary

### Executive overview
- Introduces key concepts and methodology used by the Fiscal Affairs Department (FAD) in its fiscal analysis of resource industries (FARI) framework.
- FARI is an analytical, project-level tool used for fiscal regime design and evaluation, calibration of fiscal parameters, sensitivity analysis, international comparisons, revenue forecasting, revenue management analysis (including quantification of fiscal rules), and tax gap analysis.
- FARI is an Excel-based discounted cash flow (DCF) model operating on a project-by-project basis.
- The model assumes:
  - full efficiency of revenue collection;
  - no international tax planning;
  - no opportunity to deduct costs from one project against revenues from another in the absence of a well-defined fiscal boundary (ring-fence).

### I. Background: why project-level analysis is needed
- Mining and petroleum projects have distinguishing characteristics: high sunk costs, long production periods, pervasive uncertainty, and resource exhaustibility.
- Fiscal regimes for extractive industries (EI) typically diverge from general tax systems and vary widely in:
  - structure;
  - choice of fiscal instruments;
  - rates;
  - interactions among instruments.
- Interactions among fiscal instruments and project profitability can produce effects not inferable from headline tax parameters alone; fiscal instruments must be evaluated as a package.
- FARI helps quantify how fiscal packages compare, accounting for interactions (for example, the rate at which capital costs can be deducted for CIT purposes).

### Box 1: Defining the EI fiscal regime (summary)
- The fiscal regime for mining and petroleum is the combined system of tax and non-tax instruments used to raise government revenue from natural resource extraction.
- Includes conventional instruments (royalty, CIT), contractual schemes (production-sharing, risk service contracts), lump sum payments (signature bonus), production bonuses, state participation, taxes/fees/levies that add to input costs.
- May include mandated non-revenue requirements (domestic supply at below export parity, equity acquisition by citizens).
- Can be project-specific (contractual) or sector-specific (uniform).

### II. Fiscal modeling of resource projects
- FARI evaluates fiscal regimes over the full lifecycle of resource projects, from exploration to decommissioning/closure.
- Purpose: estimate government’s share of a project’s total pre-tax net cash flows (economic rent when discounted at the minimum return to capital) and analyze interactions among fiscal parameters.
- DCF approach:
  - Inputs: fiscal parameters, annual project costs and production volumes, economic assumptions (prices, inflation, interest and discount rates), financing assumptions.
  - Calculations: project net cash flows before tax; fiscal payments per regime parameters; total government revenue from the project.
  - Outputs: indicators for evaluating fiscal regimes (neutrality, revenue raising capacity, time profile of government revenue, progressivity), and standardized economic indicators (for example, AETR, METR, post-tax IRR).

### Project lifecycle and typical timing
- Four main phases: (i) exploration; (ii) development; (iii) production; (iv) mine closure/field decommissioning.
- Exploration:
  - Petroleum: seismic surveys, exploratory drilling; seismic-to-drilling process can take between 3 to 5 years; appraisal can take between 4 to 10 years (sometimes longer) from discovery to commercial production.
- Development:
  - Mines: preparing site, infrastructure, construction, processing facilities; usually lasts between 2 to 5 years and is the most capital intensive phase.
  - Petroleum: drilling production/injection wells and building surface facilities; onshore development normally takes about a year, while offshore fields may take up to seven years depending on size.
  - Field development plan (FDP) required for petroleum projects.
- Production:
  - Can span over 20 years depending on reserves.
  - Mining and conventional gas: often stable production constrained by the nameplate capacity of processing facilities.
  - Oil: often a bell-shaped production profile with ramp-up, peak toward middle of project life, then decline unless enhanced recovery is used.
- Closure/decommissioning:
  - Site restoration and rehabilitation can be very expensive; companies may set aside funds once a certain percentage of reserves has been depleted.

### III. FARI: model inputs and project data
- Project definition: all upstream activities required to commercially develop and exploit a mineral deposit or petroleum field (exploration through closure/decommissioning).
- Inputs entered in predefined templates with placeholders for:
  - production volumes measured at the valuation point (for example, barrels of crude oil, tons of copper concentrate);
  - different categories of costs by phase (exploration, development, production, decommissioning).
- Production profile considerations:
  - Projects can produce multiple minerals, but typically have a clearly identifiable primary product.
  - Stylized models accompanying the manual assume a single commodity produced (though FARI has been adapted to handle multiple products in TA work).
  - Stage of processing at the valuation point affects royalty and tax calculations; identifying the first delivery point and price determination is critical.
- Cost profile considerations:
  - Classification and fiscal treatment of costs by project phase is central to fiscal regime evaluation (depreciation schedules, deduction rules, treatment of by-product credits).

### Outputs and indicators
- FARI calculates:
  - project cash flows before and after tax;
  - fiscal calculations for each instrument (royalty, profit taxes, profit oil, state equity, etc.);
  - division of net cash flows between investor and government;
  - standardized economic indicators such as AETR, METR, and post-tax IRR to enable comparison across regimes and jurisdictions.

*Source: Executive Summary of the FAD FARI methodology technical note.*

### Box 2. Valuation Point(s) for Fiscal Purposes

### Box 2. Valuation Point(s) for Fiscal Purposes

### Defining the valuation point
- The valuation point determines the taxable base for each fiscal instrument in the upstream fiscal regime.
- There may be as many valuation points as tax and non-tax instruments in the fiscal regime (example: royalties at the wellhead or mine mouth versus CIT at the point of sale).
- For fiscal instruments targeting resource rent, the valuation point is likely the physical point that separates upstream from midstream and downstream activities.
- Once the valuation point is defined, the corresponding price and any allowable deductions are determined with reference to this point to calculate the tax base.

### Net-back pricing for royalties and tax bases
- For an ad-valorem royalty levied on the value of production at the wellhead or mine mouth, a “net-back pricing” approach is commonly used.
- Net-back price calculation: start with the value of the product at the point where it is first sold (at arm’s length prices), then subtract the estimated costs of moving the product from the wellhead or mine mouth to the point of sale.
- The model allows deduction of transportation, refining, and processing costs incurred beyond the point where fiscal instruments are levied; these costs:
  - determine taxable income for CIT purposes (by netting back the international benchmark price to the point of CIT assessment), and
  - in some cases, calculate the royalty base.

### Classification and fiscal treatment of project costs
- FARI classifies project costs by project phase and fiscal treatment (expensed or subject to depreciation schedules).
- Capital expenditure categories in the model:
  - development costs — separated between tangibles and intangibles,
  - replacement capital.
- Treatment examples:
  - Tangible development expenditures (property, plant, equipment) may be subject to specific depreciation schedules (straight line, units of production, declining balance).
  - Intangible development expenditures (drilling, pre-stripping) are often expensed as incurred or amortized by the units of production method.
  - Replacement capital costs are likely depreciated for tax purposes and reflect post-development investments to maintain operations.
- Operating costs are classified into:
  - costs directly related to the extraction process,
  - costs related to processing, refining and beneficiation activities,
  - transportation costs incurred before the fiscal point (usually at the mine gate or FOB export point),
  - other operating costs (selling, general, and administrative expenses).
- Some fiscal regimes may limit deductibility of certain operating costs in a year; the model’s cost breakdown accounts for this.

### Model data entry and project cost profiles
- Project costs are gathered and recorded on an annual basis; annual cost categories constitute the project’s cost profile.
- Cost profiles are often more challenging to construct than production profiles because cost estimates tend to change relatively more (in magnitude and frequency) as projects move from concept development to design and implementation.
- Data are entered for each production and cost category on an annual basis; if there is no production or cost in a particular year, the corresponding cell is left blank.
- In the stylized examples used in this technical note, only costs related to successful exploration are included.
- Conventions used in examples: "$mm const means millions of dollars at constant prices; 000 ounces means thousand ounces; Mbpd means thousand barrels per day; MMBbl means million barrels."

### Economic assumptions: prices, inflation, interest, and discount rates
- Prices:
  - Price assumptions for petroleum products and most major minerals are often linked to benchmark or “spot market” prices.
  - Projections are available going out up to five years.
  - The stylized model allows the user to choose one constant price path in real terms.
- Inflation:
  - Project cost data and price assumptions are entered in real terms; fiscal calculations are done in nominal terms by applying an assumed inflation factor.
  - Model results are converted back to real terms for presentation consistency.
  - FARI uses one inflation rate applied uniformly to both price and costs.
- Interest rate:
  - The real interest rate (usually set with a margin over the long-term U.S. Treasury rate) is used with an adjustment for inflation to calculate financing charges relevant to fiscal calculations.
  - Uses include: calculating interest gains on decommissioning funds, interest charges on carried state participation repayments, and interest expense from debt financing by the contractor.
- Discount rates:
  - Main results are expressed in NPV terms in real terms; discount rates are expressed in real terms in the model.
  - The model uses a discount rate to calculate the NPV of government revenues, the average effective tax rate (AETR), and the government share of total benefits.
  - A second discount rate is used to calculate investor-focused indicators, such as the marginal effective tax rate (METR) and the project break-even price.
  - Users can enter discount rates appropriate for the case analyzed; the METR discount rate should approximate the investor’s cost of capital.

### Financing assumptions
- Project financing assumptions are simplified and pertain only to the debt-financed portion of capital raised by the investor (exception: when state participation is carried).
- The model simulates debt financing costs mainly to determine interest expense that enters the calculation of CIT.
- Options in the model include selecting the percentage of pre-production development costs financed with debt.
- Common practice: exploration costs are fully financed with equity; development costs financed with a combination of debt and equity.
- Any applicable thin capitalization rules must be taken into account when selecting the debt-financed portion.
- Additional debt parameters in the model: loan repayment period and loan interest rate.
- Table 2 (in the source) illustrates how financial and economic assumptions are set up in the model; user inputs are denoted as hard coded (yellow cells) in the model.

*Source: Box 2. Valuation Point(s) for Fiscal Purposes, _tnm1601 - Box 2. Valuation Point(s) for Fiscal Purposes*

### Box 3. Estimating the Investor’s Cost of Capital

### Box 3. Estimating the Investor’s Cost of Capital

### Overview
- The investor’s cost of capital is the rate of return required by the suppliers of capital and depends on project-specific risk: higher risk → higher cost of capital.
- Common approach: calculate marginal cost of each source of capital and take the weighted average (weighted average cost of capital, WACC). Company-level WACC can be adjusted for project risk; in FARI the company is implicitly assumed to develop a single project so company and project WACC are treated as effectively the same.

### WACC and cost components
- WACC formula:
  - WACC = w_d r_d (1–t) + w_e r_e
  - where w_d and w_e are the proportion of debt and equity respectively; r_d and r_e are the marginal cost of debt (pre-tax) and equity respectively; and t is the company tax rate.
- Cost of debt (r_d):
  - Usually reflects the yield to maturity (or annual return) on the company’s debt (for example, its long term bond rate).
  - Interest deductibility: since interest on debt financing is commonly tax-deductible, the pre-tax cost of debt is adjusted for the tax shield.
  - Many countries place limits on tax-deductible interest expense (examples noted: 1:1.5 debt to equity ratio limit; limits tied to EBITDA).
- Cost of equity (r_e):
  - Common estimation approaches: CAPM (equity risk premium added to risk-free return), multifactor and build-up models (risk premia added to risk-free rate).
- Practical modeling caveats:
  - Resource projects may involve several types of debt (senior, mezzanine, revolving facilities), grace periods, capitalized vs paid interest during development. The technical note simplifies assumptions focusing on interest expense used in taxable income calculation.

### Financial and economic assumptions (Table 2)
- Financing assumptions (inputs):
  - Percent of development costs borrowed: %70%
  - Repayment period (beginning production): years5
  - Real interest rate: %5.0%
- Economic assumptions:
  - Discount rate government: %10.0%
  - Discount rate contractor: %12.5%
  - Inflation rate: %2.0%
  - Gold smelter price: $/ounce1,300
  - Transport post-fiscal point: $/ounce25
  - Smelting and refining charge post-fiscal point: $/ounce50

### Pre-tax project cash flows, NPV and IRR
- Pre-tax net cash flows (constant dollars) formula:
  - Pre-tax CF_t = (MarketPrice x Production)_t – Trans&Proc_t – Expl&Capex_t – Opex_t – DecommCosts_t
  - Definitions: MarketPrice x Production = sales value; Trans&Proc = transportation and processing; Expl = exploration costs related to project; Capex = development and replacement capital; Opex = operating costs; DecommCosts = decommissioning/closure costs.
- Nominal cash flows are obtained by applying inflation (example assumes %2.0%).
- NPV formula:
  - NPV = CF_0 + CF_1/(1+r)^1 + CF_2/(1+r)^2 + ... + CF_n/(1+r)^n
  - r is the discount rate reflecting opportunity cost of capital and project/country risk.
- IRR definition:
  - IRR is the discount rate at which the NPV becomes zero.
- Illustrative project outcomes (examples using assumed inputs and discount rate of %10%):
  - Gold mine (pre-tax):
    - Real IRR: 41 percent
    - Project pre-tax cash flows NPV10: 508 (USD million)
    - Nominal internal rate of return (nominal): 43.5% and Project pre-tax cash flows NPV10 (nominal): 602 (USD million)
  - Petroleum project (pre-tax):
    - Real IRR: 35.5 percent
    - Project pre-tax cash flows NPV10 (constant prices): 1,021 (USD million)
    - Nominal IRR: 38.2% and Project pre-tax cash flows NPV10 (nominal): 1,200 (USD million)
- Viability criteria in FARI:
  - A project is considered viable when the post-tax NPV, using the assumed hurdle rate required by the investor, is not negative or the post-tax IRR is equal or higher than the investor’s discount rate.

### Mining fiscal regimes: tax/royalty and additional profit taxes
- Modelled base-case mining fiscal regime (Regime 1):
  - Royalty on sales value: %5 percent (assessed at mine gate)
  - Corporate Income Tax (CIT) rate: %30 percent
  - State participation (free equity): %10 percent
  - Dividend withholding tax: %15 percent
- Two alternative regimes:
  - Regime 2: adds a %20 percent surcharge on cash flows (SCF) calculated after CIT.
  - Regime 3: adds a %20 percent Resource Rent Tax (RRT) payable after a nominal rate of return of %10 percent is achieved (on cumulative results net of CIT payment).
- Royalty base:
  - In the example royalty base = NetRevenue_t = (MarketPrice x Production)_t – Trans&Proc_t
  - Royalty is deductible from income tax base.
- CIT base (CITbase_t):
  - CITbase_t = NetRevenue_t – Royalty_t – Opex_t – CapexDepr_t – Interest_t + LossCarryForward_{t–1}
  - Exploitation of pre-production capital costs can be expensed or deferred depending on regime; model switch allows deferral until production start.
- Additional profit taxes modeling:
  - Surcharge on Cash Flows (SCF):
    - Taxed when cumulative project net cash flows become positive (after royalty); when levied after CIT it deducts CIT paid in year; modeled so positive end-year balance is taxed and then reset to zero for future periods.
    - SCF base: Pre-taxNCF_t – Royalty_t (–CIT_t) + NegativeBalance_{t–1}
  - Resource Rent Tax (RRT):
    - Similar to SCF but negative balance carried forward with an uplift (minimum required return) before taxable once cumulative negative cash flows are offset.
    - RRT base: Pre-taxNCF_t – Royalty_t (–CIT_t) + (Uplift x NegativeBalance_{t–1})
- Tax administration perspective:
  - Net cash flows can be derived from taxable income by adding back net financial cost and capital depreciation and deducting capital expenditure in full:
    - Pre-taxNCF_t = CITbase(beforeLCF)_t + NetFinancialCost_t + CapexDepr_t – Capex_t
- Withholding tax and state participation:
  - Withholding tax on dividend distributions to non-residents is modeled as a final tax; model uses a “residual dividend” approach: initial positive free cash flows repay return of capital; residual positive cumulative free cash thereafter distributed as dividends and subject to withholding tax.
  - Free state equity (unpaid participation) modeled similarly to an additional withholding tax on dividends (state receives share of profits but makes no capital contribution).
  - Carried interest and carry repayment: modeled akin to RRT or SCF depending on inclusion of interest/compensation.
- Mining regime fiscal results (DATA IN MILLION USD (MARKET PRICES), Table 10):
  - Regime 1 (Royalty/CIT): Royalty $mm nominal:133; Income Tax $mm nominal:344; Additional items: State participation $mm nominal:806; Dividend withholding tax $mm nominal:108; Total government revenue $mm nominal:666
  - Regime 2 (Royalty/CIT + SCF): Royalty $mm nominal:133; Income Tax $mm nominal:344; Additional profits tax (SCF) $mm nominal:169; State participation $mm nominal:365; Dividend withholding tax $mm nominal:86; Total government revenue $mm nominal:795
  - Regime 3 (Royalty/CIT + RRT): Royalty $mm nominal:133; Income Tax $mm nominal:344; Additional profits tax (RRT) $mm nominal:154; State participation $mm nominal:806; Dividend withholding tax $mm nominal:88; Total government revenue $mm nominal:784

### Petroleum fiscal regimes: production sharing systems (PSC) vs tax/royalty
- Key distinction:
  - PSC: government retains ownership of resource; contractor recovers costs via “cost petroleum” and receives “profit petroleum” shared between government and contractor.
  - Tax/royalty: investor/licensee granted ownership at extraction point and pays royalty and taxes.
- Illustrative equivalence example (one barrel, USD100):
  - Tax/royalty: Government receives USD36 via USD10 royalty, USD12 income tax, USD14 additional profit tax.
  - PSC: Government receives USD36 via USD30 profit oil and USD6 income tax; cost recovery and taxable base differ mechanically though can be made fiscally equivalent.
- PSC mechanisms modeled:
  - DROP (daily rate of production) tiered sharing: government share of profit petroleum increases with production rate across tiers.
  - R-Factor (payback ratio): government share increases with cumulative investor payback (R-Factor = cumulative contractor net revenues / cumulative investment).
- Example PSC parameters (Table 11 highlights):
  - Production bonus at start of production: $mm 50
  - Cost recovery ceiling: %80 (Regimes 1 and 2), %100 (Royalty/Tax regime 3)
  - Investment uplift (where applicable): %15 (Regime 2)
  - Profit petroleum sharing tiers (DROP): tranche thresholds Mbpd 15, 30, 45, 60 with government share %s 40, 50, 60, 65 (and a fifth tier %75 for >60)
  - R-Factor tiers (Regime 3) R-Factor thresholds 1.00, 1.50, 2.00, 2.50 with corresponding govt. shares % 40, 50, 60, 65 and %75 beyond 2.5
  - Corporate Income Tax rate in PSC examples: %20 (PSC regimes) and %30 (Royalty/Tax regime)
  - Dividend Withholding Tax: %5
  - State-owned company (SOC) participation in joint venture: %10
- Cost petroleum and profit petroleum calculation notes:
  - Recoverable costs include operating costs; capital costs (expensed or depreciated per PSC provisions); investment uplift if applicable; decommissioning contributions; unrecouped prior costs; PSCs often impose a cost recovery ceiling (limit).
- PSC regime fiscal results (Table 16, DATA IN MILLION USD (MARKET PRICES)):
  - PSC (DROP): Production bonus $mm nominal:50; Profit petroleum $mm nominal:1,215; Corporate income tax $mm nominal:201; Dividend withholding tax $mm nominal:38; State participation $mm nominal:142; Total government revenue $mm nominal:1,646
  - PSC (R-Factor): Production bonus $mm nominal:50; Profit petroleum $mm nominal:1,293; Corporate income tax $mm nominal:187; Dividend withholding tax $mm nominal:35; State participation $mm nominal:135; Total government revenue $mm nominal:1,699
  - Royalty/Tax (comparison): Production bonus $mm nominal:50; Royalty $mm nominal:1,140; Corporate income tax $mm nominal:322; Dividend withholding tax $mm nominal:35; State participation $mm nominal:150; Total government revenue $mm nominal:1,697

### Time profile of government revenue and policy implications
- Timing characteristic:
  - Production and indirect taxes (royalty, bonuses, some production taxes) raise revenue early in project life.
  - Profit-related instruments (CIT, SCF, RRT/Rent taxes) generate revenue later, typically after investor cost recovery and required returns.
- Policy trade-offs:
  - Royalties: early, stable receipts but limited responsiveness to higher profitability.
  - Rent-related taxes (RRT/SCF): later receipts but more responsive to profitability increases; choice affects risk sharing between government and investor.
- FARI evaluation metrics used in fiscal regime design and TA:
  - From investor perspective: post-tax NPV, post-tax IRR, payback period, break-even price.
  - Indicators refer to the provider of total funds outlaid (equity, debt, retained earnings) — i.e., post-tax, pre-finance results; debt considered only in CIT calculations to show interest effect on tax base.

*Technical Notes and Manuals 16/01 — Box 3. Estimating the Investor’s Cost of Capital (extract).*

### Box 4. Investor Post-Tax Profitability Indicators

### Box 4. Investor Post-Tax Profitability Indicators

### Post-tax NPV
- Definition: The post-tax NPV is the discounted present value of the total stream of net cash flows received by the investor over the life of the project.
- Investor net cash flows formula:
  - Post-tax NCF_t = Pre-tax NCF_t – Royalty_t – Taxes_t
- Post-tax NPV formula:
  - Post-tax NPV = ∑_{t=0}^{n} Post-tax NCF_t / (1 + r)^t
  - Where Post-tax NCF_t is the investor net cash flows in year t, r is the discount rate, and n is the last year of the project.
- Interpretation:
  - Other things equal, an investor prefers projects with higher positive NPVs.

### Post-tax IRR
- Definition: The IRR is the discount rate at which the NPV of the stream of cash flows is zero.
- Application in this context:
  - The IRR here is the return on total funds (regardless of equity/debt proportions).
  - The model also calculates return to equity by netting out lender cash flow from the investor cash flow equations.

### Payback Period
- Definition: In EI projects, the payback period occurs when cumulative cash inflows from production recover cumulative cash outflows from exploration, development, operating costs and taxes.
- Variants:
  - Can be calculated on undiscounted or discounted cash flows.
  - Can be calculated on leveraged and unleveraged funds.
- Interpretation:
  - Other things equal, an investor prefers a short payback period.

### Model limitations and caveats (reasons FARI single-project results may differ from actual)
- Implied assumption of full efficiency in revenue assessment and collection by the relevant authorities.
- Implied assumption of a full project ring-fence, so that no revenue is lost by deduction of costs carried across from other projects.
- For corporate income tax, an applied assumption of no losses through international tax planning (whether by assessment or withholding).

### Additional methodological notes
- The model can be adapted to relax the assumptions listed above and to reflect different effects.
- In TA work, the FARI model has also been used to perform expected monetary value (EMV) and stochastic probability analysis.

*Source: Box 4. Investor Post-Tax Profitability Indicators, Technical Notes and Manuals 16/01 | 2016*

### Box 1. Reconciling FARI with Companies’ Financial Statements

### Box 1. Reconciling FARI with Companies’ Financial Statements

### Key challenge
- FARI assumes fiscal analysis is done on a project by project basis.
- Publicly traded companies report financial statements in a consolidated manner.
- Most mining and petroleum companies usually have a relatively large portfolio of resource projects, and may be vertically integrated with projects along the entire value chain in the upstream, midstream and downstream activities.
- These factors make it difficult to reconcile FARI results with companies’ financial statements.

### Reconciling approach
- The different components of a company’s financial statements can be used to calculate free cash flows to the firm (FCFF), or cash flow available to all the firm’s capital providers.
- FCFF can be compared against the investor net cash flows calculated in FARI.
- In theory, FCFF from an upstream company that operates only one project should reconcile with the post-tax cash flows from FARI, as a total over the life of the project.

### TABLE 1. POST-TAX CASH FLOWS FROM FARI
- FARI Calculations — Comments — Sources of Information
- Gross Revenue — Value of mineral resources — Production profile and price assumptions
- Less — Project Expenditures — Incurred capital and operating expenditures (expensed) — Cost profile
- Equals — Pre-Tax Cash Flows
- Less — Royalty — Calculated in FARI according to countries’ legislation — Fiscal regime terms and regulations
- Less — Corporate Income Taxes — Calculated in FARI according to countries’ legislation — Fiscal regime terms and regulations
- Less — Additional Profit Taxes — Calculated in FARI according to countries’ legislation — Fiscal regime terms and regulations
- Equals — Post-Tax Cash Flows

### TABLE 2. FCFF FROM COMPANIES’ FINANCIAL STATEMENT
- Companies’ Statements — Comments — Sources of Information
- Gross Revenue — Sales value of resources — Income statement
- Less — Cost of sales and SG&A — Operating costs and SG&A — Income statement
- Less — Depreciation charges — Book depreciation — Income statement
- Less — Interest expense — Interest on debt — Income statement
- Less — Tax payable — Royalties and taxes payable — Income statement
- Equals — Net income
- Plus — Non-cash charges — Depreciation expense and other non-cash charges — Income statement and balance sheet
- Plus — After-tax interest expense — Calculated as interest expenses times (1 – tax rate) — Income statement
- Less — Capital expenditures — All capital costs, as incurred — Income statement and balance sheet
- Less — Working capital investment — Calculated as current assets minus current liabilities — Balance sheet
- Equals — Free cash flow to the firm — Similar metric to post-tax cash flows from FARI

### FCFF calculation and interpretation
- FCFF adjusts financial statement flows to better reflect the cash flows available to all investors in the firm.
- FCFF is calculated by:
  - adding non-cash charges (such as depreciation) and after-tax interest expense to net income, and
  - subtracting capital expenditures and non-operating investment in working capital.

### Concluding note
- In some countries the income statement is referred to as profit and loss statement (or P&L).

*TNM/16/01 International Monetary Fund Fiscal Affairs Department 700 19th Street NW Washington, DC 20431 USA Tel: 1-202-623-8554 Fax: 1-202-623-6073*

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