The Royal Audit Authority (RAA) in it performance audit report on the mining sector has found weak and ineffective monitoring by the government and also certain practices by mining companies which favored promoters and disadvantaged minority shareholders.
The report titled, ‘Performance Audit of Tax on Mining and Quarrying Sector,’ covers the period of 2008-2012. Out of the total 33 mines and 48 stone quarries at the time RAA visited all 33 mines and 26 out of 48 quarries.
It says that there was Nu 1.125 bn financial implication on account of profits foregone by public companies due to related third party transactions, revenue foregone by the government due to inconsistent provisions and ineffective enforcement of tax laws and issues related to corporate governance of the mining companies.
The report also criticizes provisions or their absence in the Companies Act 2000, Income Tax Act and also the practice of certain mining policies which also allowed the above to happen.
The RAA report is a result of resolution passed by the National Council in 2013 asking for RAA to audit the mining sector.
Potential revenue lost by the government
The total calculation of the potential revenue lost by the government comes to around Nu 756 mn through royalties, mineral rent and taxes.
RAA pointed out that the government gained Nu 1.324 bn as revenue by auctioning Coal to SD Eastern Bhutan Coal Company, Gypsum to Druk Satair Corporation Limited and Dolomite to Jigme Mining Corporation Limited. The RAA says that in contrast the government’s ‘first come first serve policy’ in allotting other mines and quarries instead of public auctioning create loss of revenue and impedes transparency.
It says that based on the Minerals and Mine Management Regulations (MMMR) 2002 ‘first come first serve’ is only for where mineral deposits have been explored by individuals or companies but in most cases it was the government that had done the exploring.
The RAA based on the market and auction rates calculated that in the case of seven mines given on first come first serve basis the government had lost Nu 307.392 mn. It says this figure would be even higher if all the mines allocated in this manner are taken into account. This same figure was reflected in an earlier RAA report on Leasing of Government Land, Forest and Mines.
The RAA report said that despite the requirement to revise royalty and mineral rent rates it was not done for 8 to 13 years. It said that even the revision made was very minimal.
A comparison of royalty rates carried out by RAA showed that the export rate royalty applied for Dolomite at Nu 40 per metric tonne (MT) was lower than other minerals which was at Nu 100 MT. The RAA computed the notional loss at Nu 328.860 mn from 2008 to 2012.
Here the Ministry of Economic Affairs (MoEA) responded that the rates must be set low because the sales value of dolomite is lower than other minerals. It argued that the computation in loss of revenue would be wrong as minerals were of enormously varying value.
The RAA’s review of the tax administration of mining companies showed that weak enforcement of tax laws had resulted in revenue loss aggregating to Nu 119.77 mn.
Of this RAA has criticized Clause 2.6 Part III of the Income tax Act which exempts tax on incomes from hire of privately owned businesses. It says it resulted in foregone tax revenue of Nu 87.99 mn from individual private transporters hired by Jigme Industries Private Limited (JIPL), Druk Satair Corporation Limited (DSCL) and SD Eastern Bhutan Coal Company Limited (SDEBCCL) for transporting minerals. RAA says that granting tax exemptions to truck owners earning a huge income does not make sense. In one instance an individual transporter earned as high as Nu 5.292 mn in a year but was exempted from paying tax.
The Finance Ministry has assured RAA that it will look into the issue when the amendment of the Income Tax Act 2001 comes up.
RAA pointed out that the government had foregone tax revenue of Nu 12.47 mn from Jigme Mining Corporation Limited (JMCL) and DSCL by allowing the Environmental Restoration bond to be made a deductible expense.
Also in another case fines paid by Druk Satair was allowed as deductions resulting in Nu 1.64 mn loss in tax revenue.
In one instance non declaration of a Nu 6.75 mn commission by a JMCL Director resulted in Nu 1.68 mn in tax revenue losses.
As per the rule 1 Part II of the Income Tax Act, the losses of business units engaged in the trading sector are not allowed to be offset against the profit of another entity except for manufacturing and service sectors subject to certain conditions.
However, with no similar provision for business units operating under an incorporated company Singye Stone and Sand Factory under Singye Group of Companies paid Nu 15.98 mn less in taxes from 2008-2012 after offsetting its profits against the losses of other units. At the same time the RAA said that since there was no specific law preventing such offsetting of losses it does not render any basis for the RAA to provide any opinion on such practice except that it reduces taxable profits.
Here the MoF said that it will take into consideration such instances when the Income Tax rules are amended.
No protection for minority shareholders and conflict of interest deals
Some major mining companies, as a requirement under law floated 30 percent of their shares to the general public. However, RAA found that except for some disclosure there was no adequate legislative protection for such shareholders and so some companies entered into transactions that prime-facie was not in the interest of minority shareholders.
In case of dolomite mining JMCL a public company was formed with 70% holding by promoters and 30% by the public. Later JIPL was formed as a private company by JMCL for crushing and screening of dolomite for export and supply to domestic markets. JMCL as a company held 51% shares and the promoters held 49% of the shares. The proportion of shareholding of minority shareholders in JIPL had decreased to 15% and the promoter’s share increased to 85%.
Similarly in the case of DSCL the formation of a subsidiary company called Druk Gypproducts and Chemical Limited (DGCL) a public mining company had resulted in substantial reduction of minority shareholders from 31% to 8.99% and increase from 35% to 51% for promoters.
The RAA says that in the above cases besides diluting the share of minority shareholders it was also a way to transfer more profits into the hands of the promoters.
JMCL responded to RAA saying that neither the auction terms nor the Companies Act 2000 prohibited JMCL from forming a subsidiary company and all decisions were made by the JMCL Board within the legal framework of the country. It also said that all companies were legal business units disclosed in the annual audited statements.
DSCL responded saying that DGCL was formed to continue the business of DSCL post 2018 after expiry of the lease period as its renewal is not guaranteed. It was also said that the same shareholding pattern can’t be maintained in DGCL as it is a different legal entity.
The RAA report says that as per the Companies Act except with the Board’s consent no Director of the Company or his relatives company can enter into any contract with the company.
However, the RAA found instances of related party transactions where public companies entered into business entities owned by a Director of the company at rates above market rates favoring the business entities by mere transfer of secured profits by the company.
The involvement of JIPL in JMCL as an intermediary company gave rise to conflict of interest and rates charged to JIPL were determined in 2005 and was not found revised since then.
JMCL responded saying that under normal circumstances, the unit price should have reduced with increase in sales volume but despite increase in sales volumes to JIPL the prices stayed the same.
RSA Pvt Limited owned by the Chairman of DSCL a public company was involved as intermediary for export of gypsum to Bangladesh and Nepal. The prices charged to RSA Pvt Limited was lower than other domestic companies indicating undue favors extended to the company as a result of which DSCL had forgone profit to the tune of Nu 45.66 mn. Besides it was also noted that 10 to 12 trucks owned by the spouse of the General Manager sales department DSCL were engaged for outward transportation of Gypsum.
RSA Pvt Ltd responded that cost components such as transportation, handling and bank charges were missed out by RAA in computing the figure which should me much less. It also said that RSA Pvt Ltd had increased the sales of DSCL and introduced gypsum to Bangladesh and Nepal.
SDEBCCL, a public company had engaged Sherja hiring units owned by the current Chairman of SDEBCCL for mining and restoration activities. The comparison of hire charges with BSR showed that the firm paid at exorbitantly higher rates due to which SDEBCCL had foregone profit amounting to Nu 177.84 mn.
SDEBCCL responded saying that hiring of Sherja was in line with the Companies Act and BSR rates applicable in construction could not be used for mining. It said that there was no favor as Sherja was the only unit available then and it had resulted in savings, reliability and availability.
The MoEA responded to RAA saying that there is lack of clarity on the statutory mandate of their office to monitor related party transactions. The Ministry also stated that they had been dependant on the disclosure made by the Board and the statutory Auditors report.
The report said that though there are no legal stipulations and guidelines most of the public mining companies, by virtue of holding majority shares elect themselves to posts of Directors and also as the CEOs. It says there is a common practice among these companies to draw a substantial part of the company’s profits by way of excessive salaries, commissions and bonuses which erode a substantial part of the company’s profit.
It points out the high salary of the CEOs of JMCL and SDEBCCL which is much higher than salaries of CEOs of State Owned Enterprises and senior civil servants. It also says that from 2010 to 2013 Nu 60 mn was paid as commission to Directors of JMCL while another Nu 30 mn was paid to Directors of JIPL. Another donation of Nu 4.9 mn was made by JMCL to directors and other individuals from 2009-2012. In SBDECCL personal travel and health expenses of Nu 8 mn of the CMD in the 2009-2012 period was borne by the company.
Both JMCL and SDEBCCL pointed out that all salaries and benefits were paid after approval from their boards based on the nature of their responsibilities and moreover the Companies Act did not have limitations on pay and perks. JMCL also said that it was international practice to pay a part of the profit to the Directors as commissions and it was a legitimate expenditure not prohibited by the Companies Act.
The RAA based on the above cases said that the Companies Act does not specify adequate remedial measures in cases where ineligible expenses are charged to the company affecting other stakeholders. The RAA also that there was not enough provisions in the Companies Act in prevent formation of intermediary companies to promote the interest of a few owners.
The MoEA agreed and said that new enabling provisions are already inserted in the Companies Bill which has been tabled in the Parliament.
The RAA on review of the of the system of transportation of minerals from the mine sites to stockyards pertaining to dolomite, gypsum and coal found lack of appropriate monitoring controls by the DGM. The common problem noted in all mines was that mine inspectors from DGM were not fielded at the mine sites. There was no weigh bridge installed at the mine site and there was no reconciliation of quantities of materials extracted at the mine site and quantities received at the stockyard. The practice of issuing Transport Permits for transportation of minerals was a mere formality and there was no authenticity of information in it. RAA noted that pre-signed TPs were directly issued to company officials at the site.
The RAA noted that based on the above there was hardly any control mechanism to keep track of information on actual extraction at the mine site and also created potential for deflection to places other than stockyards and hence result in loss of royalty and revenue to the government.
On review it was found that despite being mandated DGM does not have a central database on mines as required under mining regulations. Financial records of mines were mostly missing or there were no records at all. Reconciliation of figures at points of entry and exit were not accrued out with figures maintained by business units, raising questions on information integrity and reliability. There were instances of irregular submission of report by the operating mines.
The report found that Nu 9.71 mn worth of Environmental Restoration Bond had not been deposited by 19 mines and quarries that had closed.
The report also found that captive mines given to certain companies were selling minerals to other companies and some companies contracted out the captive mines to other business units in contravention of the mining lease agreement. These included the captive mines of Bhutan Carbide and Chemicals Limited, Bhutan Ferro Alloys, Lhaki Cement and Druk Cement.
RAA found that most stone quarries declared consistent losses. However, further examination of financial records of some of these quarries revealed in some cases the sales were understated and expenses overstated to reduce the taxable profits.
It was also found that some stone quarries had not yet started operations even two years after getting the lease and there was were also issues of quarry lease rights being transferred which were all in contravention of the law. It was also noted that the Tshodremithang stone quarry in operation from 2008-2013 and Sha Ngawang granite in operation since 2008 were not even registered with the Regional Revenue and Customs Office and though as per DGM records the quarries showed production they were not in the tax ambit.
The average contribution of the mining and quarrying sector to the GDP from 2008 to 2012 has remained at 2.20%.
The RAA report will be deliberated in the National Council on 1st December 2014.