The question of why high global prices for raw materials such as copper or gold do not always guarantee superprofit for a specific deposit, as well as the need to introduce a special royalty tax alongside profit tax and subsoil use tax, is discussed in a column for 'Gazeta'. Dilshod Sultanov, Deputy Director of the Institute for Reducing the Share of the Shadow Economy, Improving Tax and Customs Administration, and Fiscal Analysis at the Ministry of Economy and Finance, explains the principles of this tax in Uzbekistan, emphasizing that it takes into account not only the income received but also the costs incurred by the project.
Subsoil resources differ from standard production assets. Although the investor assumes risks related to exploration, construction, and operation, a successful deposit can generate income significantly exceeding cost recovery and expected rate of return. Part of this excess income is classified as resource rent, which is linked to the uniqueness and scarcity of the natural resource.
Normal profitability is defined as the minimum level of profit sufficient to compensate the investor for the invested capital, taking into account the project duration and associated geological, production, and market risks. This profitability makes investments economically viable but does not guarantee profit and does not have a universal meaning for all deposits.
When global prices for minerals rise, it is natural to assume that royalties (subsoil use tax) should simply be increased. However, a high price itself does not mean that every deposit will generate superprofit. Therefore, the task of the tax system in the mining sector goes beyond simple collection of profit tax; it must ensure the state's share of resource rent, including that arising during periods of high global prices.
Accounting profit does not coincide with rent because it includes the normal return on capital, depends on depreciation and financial structure, and is usually calculated for a legal entity, not for an individual project. Furthermore, limiting each project is critical to prevent the erosion of the tax base due to other types of activities or the inclusion of costs from other deposits.
How the royalty tax functions
In an ideal symmetric model, the state participates in both positive and negative financial flows of the project. In practice, the budget rarely reimburses expenses directly. Instead, the negative balance is carried over to future periods and increased by an established surcharge. Capital and operating costs form the negative balance of the project, and the tax arises only when subsequent revenues cover this balance, including the accrued surcharge. Thus, the project does not pay the royalty tax while it is recovering its initial investments.
The essence of the royalty tax is to provide the state with a share of the income remaining after covering the allowable project costs. Capital and operating expenses reduce the accumulated result, and the uncovered negative balance is transferred to the next period with a surcharge. It is important to note that financial expenses do not reduce the rent base. The longer the costs remain unrecovered, the larger the amount that the project must cover before generating rent income.
International experience and Uzbekistan's approach
In its report 'Analysis of Cash Flows in Mining Tax Regimes,' IMF experts point to the significant advantages of combining three instruments for many countries: moderate royalties to generate revenue from the start of mining, profit tax to tax ordinary profits, and a royalty tax to extract part of the superprofit.
The OECD report on critical raw materials in Central Asia notes that Uzbekistan has a special royalty tax on mineral extraction at a rate of 25%. The OECD recommends maintaining this tax, testing its parameters on economic models, and considering limiting the deduction of historical costs to which the surcharge is applied.
The rent nature of the tax is determined not by its name or high rate, but by whether the tax base considers the accumulated result of a single project, cost recovery, the investor's normal return, and the time factor of income generation. This is what distinguishes the special royalty tax from royalties and profit tax. In Uzbekistan, as of January 1, 2022, the taxation system for mining projects was transformed into a three-tiered structure, including profit tax, subsoil use tax, and a special royalty tax.
The special royalty tax applies to certain categories of mining projects. For subsoil areas where mining began between January 1, 2024, and December 31, 2025, full exemption from this tax is provided for the entire development period. For other projects, the obligation to pay arises only after the accumulated costs are covered, including the established surcharge. This structure was created to maintain the investment attractiveness of projects while ensuring the state's share of resource rent and price superprofits.
Conditional example of liability for the special royalty tax
According to the given example, the obligation to pay the special royalty tax arises only in the fifth year of the project implementation. During the first four years, project revenues are directed towards covering the accumulated rent loss, which includes incurred costs and the uplift charged on the uncovered balance. After fully covering this accumulated loss, only in the fifth year does the accumulated result become positive in the conditional example—about 60 units. At a rate of 25%, the amount of the special royalty tax will be 15 units.
It is important to understand that this does not mean that the funds from the first four years are physically transferred to a separate account to cover the loss. It is about tax calculation: as long as the accumulated base remains negative, the special royalty tax is not levied. A feature of the special royalty tax is that capital investments are accounted for in determining the tax base all at once, not incrementally through depreciation. Since the cost of capital investments has already reduced the special royalty tax base, depreciation in subsequent years is not deducted again, which excludes double counting of expenses.
The size of the indexation of the uncovered negative result is determined annually. The basis for calculation is the yield of a US dollar-denominated international bond of Uzbekistan maturing in 2031, as of December 31 of the relevant year, plus two percentage points. Thus, the indexation coefficient accounts for the change in the value of money but depends on the market yield of government securities.
In the conditional example, at the end of the first year, the investor's capital investments amounted to 250 units. With an international bond yield of 5.5%, the indexation coefficient is 7.5% (5.5% plus two percentage points). Consequently, the accumulated rent loss of approximately 268.75 units is carried over to the next year. For calculation simplicity in this example, the indexation coefficient was set at 7.5% for all years, although in practice it is recalculated annually and may change depending on the bond yield.
The surcharge established by law is not a guaranteed investor return; it performs a normative function of transferring unrecovered costs and only partially accounts for the time value of money.
Why a high price does not yet mean superprofit
Some countries use two main methods to tax additional income of mining companies: increasing royalties when global raw material prices rise or introducing an additional profit tax. An increased profit tax takes into account company expenses, but it is usually calculated for each financial year and does not show whether a specific project has paid off considering past losses and investments. Therefore, a high profit tax rate itself does not transform it into a royalty tax. In contrast, the royalty tax assesses the result of the deposit over a longer period and arises only after achieving payback.
Another way to increase budget revenues when global prices rise is to increase the tax rate calculated based on the volume or value of mined raw materials. The advantage of this approach is that the budget receives additional funds immediately, without waiting for the company to make a profit. Nevertheless, it has a limitation: such a tax hardly differentiates the profitability of deposits if the value of the sold raw material is the same.
Consider two deposits selling metal at the same price and receiving the same revenue. In the first deposit, the ore is richer, and infrastructure (roads, electricity, processing) is already available. In the second deposit, the ore is deeper, requires complex processing, and more expensive transportation. The royalty for both projects will be the same, although their actual profits may differ significantly. For the first project, the increased tax may extract part of the superprofit, whereas for the second, it may take part of the ordinary profit or even funds needed to return investments.
This is especially relevant for new, capital-intensive, and geologically complex deposits, where the superprofit may be insignificant even with high raw material prices. Therefore, increasing royalties in line with global prices does not provide an accurate assessment of superprofit, as such a tax ignores costs, project payback, and deposit complexity. The higher the royalty rate, the higher the risk that developing expensive reserves will become unprofitable. This does not mean that royalties should be abolished; a moderate tax ensures revenue for the budget from the beginning of the deposit's operation, before profit is made, but royalties should not be the sole method of extracting superprofit.
What is required for effective administration
The special royalty tax determines superprofit more accurately, but its administration is more complex than a regular mining tax. The state must check not only the volume of raw materials and their selling price but also the company's expenses. When administering such a tax, several key risks must be taken into account, including the possible inflation of costs, since the more declared expenses, the later the moment the tax arises. Therefore, tax authorities must have the ability to analyze and compare the cost of construction and equipment in detail.
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