‘Terrible Transactions’: How much does mining benefit the Brazilian state?

We’re sharing here details of a study by the Instituto Justiça Fiscal (the Tax Justice Institute) in Brazil researched by economist Guilherme Spinato Morlin with coordination and advice from the Instituto Justiça Fiscal. Instituto Justiça Fiscal directors Clair Hickmann and João Carlos Loebens take up the story:

‘Terrible Transactions’

In recent years, Brazil has experienced two major environmental and humanitarian tragedies caused by mining activities. In 2019, a dam collapse involving the mining firm Vale killed more than 240 people. In 2015, a dam from the mining company Samarco collapsed killing 19 people and polluting agricultural land and drinking water for hundreds of thousands. It left behind a trail of contaminated mud that destroyed about 700 kilometers of the river Rio Doce.

Billions in public funds will now be spent by the Brazilian State to address the problems, not even taking into account the loss of human lives. Although mining is an important part of the country’s economy, these disasters lead us to reflect on who wins and who loses with mining activity. How much in taxes and foreign currency inflows does mining actually generate for the Brazilian state?

A study by the Instituto Justiça Fiscal (the Tax Justice Institute) published in 2017 shows that the amount of tax revenue and foreign currency inflows generated by mining from 2009 to 2015 don’t justify perceptions about its importance to the economy. The research shows that taxes paid by the industry are much lower than they should be. Much of the profits are shifted to countries considered corporate tax havens to avoid taxes in Brazil.

The Instituto Justiça Fiscal study estimates that from 2009 to 2015 the losses of revenue for the Brazilian State amounted to R$50 billion, which is equivalent to US$ 13.3 billion. This includes US$ 12.4 billion in income taxes and US$ 0.9 billion due to the underpayment of the Financial Contribution for the Exploration of Mineral Resources (CFEM) concerning Properties of the State, which is a contribution paid by mining companies to the Federal Government as compensation for the exploitation of non-renewable mineral resources.

Loss in Brazilian wealth

Extraction of most of the iron ore is for export and not for use within Brazil. The iron ore is shipped directly from Brazil to Asia, which is its largest consumer.     

The trick used to pay less taxes in Brazil is the under-invoicing of exports, which reduces taxable profits. This tax manoeuver is done through a subsidiary of the same company registered in a corporate tax haven, which plays a fictitious role of buyer of the products exported by the Brazilian company.

The sales destined for China or Japan are settled with a below-market price by the tax haven subsidiary. This subsidiary then resells the goods for the actual price to Asian companies. The profits of these Brazilian mining companies are transferred to its tax haven subsidiary, where taxation is very low or non-existent. These sums are thus lost to Brazil, where wealth is extracted and transferred to a country that’s not adding any value to the product.

We’re a country blessed with natural resources, yet we’re still poor. Our wealth is extracted and sent to other countries, leaving only pollution, environmental damage and loss of human lives.

The current cycle of Brazilian mining does not differ much from the gold rush in colonial times. The extraction and export of gold was the main economic activity carried out by the Portuguese Crown at a time when Brazil suffered its worst abuses and domination by European countries.  Finally, the gold mines of Minas Gerais (a name that means ‘general mines’, referring to the abundance in wealth that could be extracted from the site) ran out and the Brazilian economy descended into poverty and inequality.

Brazilian singer Chico Buarque has a song that goes something along the lines of

“thus slept our mother country, absent minded

Without realizing it was taken apart

In terrible transactions”

“Dormia, a nossa pátria-mãe tão distraída
Sem perceber que era subtraída
Em tenebrosas transações”

It seems that we are still asleep, absent-mindedly, without realising that our wealth continues to be taken away from us.

Who is the biggest buyer of Brazilian ore?

The Instituto Justiça Fiscal study reveals a curious and strange fact: Switzerland is the biggest buyer of Brazilian iron ore. Apparently, it acquires more than 80% of the product exported by Brazil, yet Ministry of Industry and Commerce reports show that Brazil’s major trading partner in this area is actually China. In 2016, Switzerland acquired 247,387,719 tons of iron ore, about 81% of the volume Brazil exported that year. 62% of that went to China. But why is the purchasing country different from the country the commodity is being shipped to?

The triangulation and under-invoicing of transactions confirms that Brazilian exporting companies are practicing fictitious triangulation by exporting to themselves through their subsidiaries located in Switzerland at a below-market price. The actual goods are shipped directly to China. Switzerland is considered a corporate tax haven which taxes the profits of foreign companies very little.

Up until 2005, a small Caribbean country, the Bahamas, also considered a corporate tax haven, apparently ‘bought’ 58.5% of Brazilian iron ore. But from 2007 onwards, Switzerland became the main buyer of the product. This did not happen by chance. In 2006, the Vale company opened a subsidiary in Switzerland. The following year, Switzerland bought 68.5% of the product exported by Brazil, rising to 87.5% in 2013.

Capital Outflows from Brazil – between 39 and 49 billion dollars

The under-invoicing of iron ore exports also negatively affects the Brazilian Balance of Trade. The Instituto Justiça Fiscal study estimates that capital outflow of foreign currency due to the under invoicing of ore exports amounted to US$ 39.1 billion between 2009 and 2015, an average loss of US$5.6 billion per year. This estimate is based on the comparison between the export prices declared by Brazilian companies and the trading prices of ore in the international market. An alternative estimate, which was based on the difference between export prices registered in Brazil and the import prices registered in the countries of destination (China), resulted in even bigger losses – US$ 49.06 billion in the same period.

Between 2009 and 2015, Iron ore reached China at a price 20% to 89% higher than that which the exporting companies declared to Brazilian authorities. The average export price declared to the Brazilian authorities (MDIC – Ministry of Development, Industry and Trade) in 2011 was US$ 116.90 per ton. Chinese importers, however, reported that they paid US$ 178.40, or 52 percent more than that. Meanwhile, the average international price was US$139.66, still 20% higher than the price declared in Brazil.

In 2015, the international ore price was 33.78% higher than the price of exports declared by Brazilian companies, and Asian companies declared to the United Nations that they had paid 89% more. The difference was that the profit was improperly transferred to Switzerland. Who moved Brazil’s cheese?

To stop these harmful practices, we believe that Brazil should have a law allowing the tax authority to arbitrage the price of the sale in case of triangulation between companies in the same group. The Brazilian legislation of transfer pricing already establishes that companies must apply the price practiced/listed? in the public stock exchange in the trade of commodities. But in the case of iron ore exporting, this was only partially applied. Internationally, the exchange of information between tax administrations and international organisations could help a lot. Companies in the acquiring/purchasing? country should inform/declare? the price they’re paying? paid to the authorities of the selling country.

New times, old practices

In the old days, the wealth of the colonies was extracted and subtracted by the colonising governments. In our times, the same happens, only the exploiter has changed: now it’s transnational corporations that take away our wealth. We are still a colony.

Globalisation and the free flow of capital contribute to the expansion of multinational corporations and the extraction of wealth belonging to less developed countries. In recent years, transactions within between companies whave grown, representing more than 60% of global trade. These phenomena have facilitated the displacement of production centres from high cost countries to low cost countries. This has led many countries to reduce their taxes and to grant tax benefits to try to attract investment. The granting of these benefits has generated an international tax war and produced substantial negative effects on the economies of several countries.

This leads to transnational corporations and very wealthy individuals managing to escape from income tax, with the tax burden being shifted to the poorest through increased taxes on consumption. The risk here is that tax systems may become even more regressive if measures are not taken to address this problem.  

The effects of this unlimited globalisation are: fiscal crisis in nations, more income concentration and social inequality, and the loss of public confidence in governments and the political system.

It is difficult to deal with the problem while politicians and governments are captured by private interests and old practices of wealth extraction and income concentration continue to be the norm.

Given this, we should not wait for iron ore mines to run out like gold in the colonial era. We must turn this unfortunate page of our history. We cannot allow our motherland to remain absent mindedly asleep without realising that it is being extracted through terrible transactions.

Image: Brumadinho, Minas Gerais (47021723582).jpg Author Ibama https://commons.wikimedia.org/wiki/File:Brumadinho,_Minas_Gerais_(47021723582).jpg CC BY = SA 2.0