Finer points of mining • Legal Communiqué: Mining in Ecuador: Regulation and incentives

The Ferrere law firm outlines the legal framework regulating the mining sector in Ecuador, as well as the various incentives and guarantees available to investors.

TRADITIONALLY, ECUADOR HAS BEEN AN OIL-DEPENDENT ECONOMY.

However, in the last decade, mining has acquired a more significant role. Local policies have promoted this activity, and two world-class projects have now entered into the exploitation phase. Moreover, in recent years, the country has maintained a pro-mining stance and developed regulations to protect mining activities as well as provide incentives for investors and investments carried out in this sector. Such measures have had a favorable response from important stakeholders of the sector.

REGULATION

Mining activities are highly regulated in Ecuador. The legal framework in Ecuador that regulates the mining industry includes: the Constitution; the Mining Law; the Environmental Law; Regulation of the Mining Law; Environmental Regulation for Mining Activities; and

Regulation for the Special Regime of the Small Scale and Artisanal Mining and other specific regulations (i.e. Assignment of Mining Rights).

Article 313 of the Constitution establishes that natural resources are strategic sectors that the state has reserved the right to

(A) (B) (C) (D) (E) (F)

administer, regulate, control, and manage, taking into consideration the principles of environmental sustainability, precaution, prevention, and efficiency. Article 316 allows the state to delegate the participation in the strategic sectors to mixed companies in which the state holds a majority interest or, exceptionally, to a private party according to the sectorial law. Furthermore, the Mining Law sets the general provisions regarding mining rights and obligations. The law defines mining rights or mining titles as the result of being granted a mining concession, mining exploitation contracts, licenses, and permits, as well as from the authorizations to install, operate benefit facilities, smelting and refining, and marketing licenses. Additionally, Ecuador has adopted important legislative measures to promote and protect mining activities. Through the development law, Ecuador eliminated the Windfall Tax applicable for mining activities, mining royalties payable to the state were modified, and dispute resolution clauses in international arbitration centers were included. Likewise, due to the adoption of Ministerial Agreements No. 34 of August 29, 2018, and No. 419 of February 1, 2019, the exploration instructive was modified to allow scout drilling activities in the initial exploration stage, which allows companies to perform drilling activities in 30 platforms in concessions under several specific conditions. Also, the government issued the Mining Policy 2019-2030, which is based on six main axes: (i) economic development: (ii) environmental and social sustainability; (iii) administration; (iv) legislation; (v) regulation, control, and fight against illegal mining; and (vi) investigation and development.

Moreover, concessions are defined as the administrative act whereby the state grants a private party a mining title, with the exclusive right to explore and exploit minerals, which is personal, transferrable, and subject to encumbrance, under the compliance of certain legal requirements. The registration of the mining title shall be authorized by the Agency of Regulation and Control of Mining (ARCOM), and such an act will be formalized by registration in the Mining Registry. Concessions are generally granted for a period of 25 years, subject to been renewed for a consecutive period for the same time if favored by the Ministry of Environment and ARCOM, and they cannot exceed 5,000ha.

Large-scale mining may be conducted through an exploitation mining agreement. These contracts must be executed between holders of mining concessions and the state within six months from the date of the resolution that declares the commence

ment of the exploitation phase, which will regulate the obligations of the private party with regard to environmental matters, local communities, guarantees, payment of royalties, suspension of mining activities, and closure of the mining site. Contracts may have international arbitration clause for disputes according to the Organic Law for Productive Development.

Additionally, the Mining Law contains three taxes or levies that miners shall pay to the state: (a) a payment of the equivalent to five basic unified compensation (BUC) for the right to petition a mining concession; (b) an annual license for the maintenance of the concession equivalent to 2.5% of a BUC for each hectare of the mining concessions payable from the moment when the concession is granted; and (c) a royalty for the right to exploit minerals between 3% and 8% of the sales price of the principal and secondary metals. To establish the percentages criteria of progressivity, production volumes and price must be considered. The state must designate 60% of the royalties collected to sustainable social local projects. Income tax has a fixed rate of 25%.

Listed below is a comparative table of the main characteristics for each scale.

INCENTIVES

On May 16, 2017, the president of Ecuador issued executive decrees No. 1399 to No. 1414 terminating all of Ecuador’s current bilateral investment treaties (BITs) with other countries and to proceed with the notification to its counterparties.

As an alternative to the protections established in the BITs, Ecuador included in its legislation the Investment Protection Agreement (IPA), regulated under the Organic Code of Production, Trade, and Investment (COPCI) and the Law for Productive Promotion, Attraction of Investments, and Employment Generation. The agreement is designed to set the terms and conditions under which an investment will be made in the recipient country.

Such an agreement can be executed without a BIT between Ecuador and the investor. The main rules or specifications that govern the agreement are the following:

1. If the foreign investor wants to execute an IPA, the foreign investor must submit a request to the national authority responsible for the investment.

2. In the IPA, the state will establish the general guarantees for the investment recognized by the Constitution, COPCI, and international agreements ratified by Ecuador. The legal obligations incorporated in the investment treaties are typically the ones established in a BIT, such as non-discriminatory treatment and the right to own property. Additionally, this agreement could include tax stability clauses.

3. Terms and conditions of the IPA may only be modified in any way by mutual

written agreement of the parties, evidencing such modifications.

4. Arbitration, as an alternative method of dispute resolution, allows the foreign investor to solve disputes in a different specialized and neutral forum.

Ecuadorian legislation establishes that in the event an IPA exceeds USD10 million, the state must agree on a national or international arbitration. Despite this alternative method, it is also possible to establish a multi-step dispute resolution clause that features a negotiation phase or mediation phase as an early stage.

In the event the state agrees to international arbitration in the IPA, any controversy resulting from the investment or the agreement, its non-compliance, resolution, or nullity will be solved, at the claimant’s choice, through arbitration under, among others, the following rules:

A) United Nations Commission on International Trade Law (UNCITRAL) administered by the Permanent Court of Arbitration (CPA);

B) Arbitration Rules of the International Court of Arbitration of the International Chamber of Commerce based in Paris (CCI); or,

C) Inter-American Commercial Arbitration Commission (CIAC)

5. The IPA has a validity of 15 years and may be extended once only for the same term.

Regarding incentives, there is a meandering legal framework in Ecuador, but for mining investors, heavy regulations are not a new issue. With the right advice and a careful analysis of cost versus benefits, investment incentives for metallic mining in Ecuador could be extremely profitable.

Ecuadorian law provides for several incentives, including tax exemptions, though not all investors may apply all incentives. The first thing to note is that some incentives are applicable only for specific economic activities, so-called prioritized sectors. Mining is not among the prioritized sectors; consequently, investors in mining may apply in the first instance for the general incentives, which includes:

1. Additional deductions for income tax for expenses in cleaner production

2. Remittance tax exemption in the payments of foreign loans

3. Deferred payment of import duties

4. Specific incentives for companies that open their shares to its workers

Besides, investments in metallic mining, medium and large scale, may apply for taxation stability. Taxation stability includes the corporate income tax rate and regulations regarding tax calculation. The IPA also may grant stability for the remittance tax regulations and other direct taxes. As well, the investor may obtain stability for the rate and exemptions of the sales tax (value-added tax). Mining investors cannot obtain corporate income tax exemptions, an incentive reserved for prioritized sectors.

The law grants the previously mentioned general incentives for all new investments without the formality of an IPA. On the other hand, the investor must sign an IPA with the Ecuadorian government to obtain taxation stability. Stability will last for the same period of the agreement.

It is necessary to dedicate a special men

tion to the legal stability that includes specific regulations declared essential in the relevant licenses or the concession contract. The concession contract itself grants legal stability. The investor on its own will may request the inclusion of this incentive in the IPA. In such case, the investor must be careful of the coherence of its concession contract and the IPA.

In summary, an investor in the metallic mining sector obtains minor tax incentives by law. Signing an IPA, the investor may obtain taxation stability on the corporate income tax, sales tax, and remittance tax. As well, by the concession contract, the investor could obtain legal stability for provisions deemed essential for the investment. Finally, the IPA will include an arbitration procedure for investments over USD10 million.

CURRENT TRENDS

In 2019, the mining industry reached an unparalleled milestone, as two major largescale mining projects started production. The Mirador and Fruta del Norte projects began their production of copper and gold in June and November, respectively. Moreover, on December 8, the first export of 177.9 tons of gold concentrate was made.

According to the Ministry of Energy and Non-Renewable Natural Resources, in 2018, Ecuador exported more than USD274 million and collected USD55.98 million in royalties, patents, and profits1. In addition, mining had an important effect on foreign direct investment, as 53% of the FDI received by Ecuador in 2018 was directly related to the mining sector. These numbers are expected to increase exponentially as mining activities grow in a sustained fashion.

Moreover, financial opportunities with the state-owned company, ENAMI EP, are of growing interest. ENAMI EP has entered into several joint ventures with other companies, one of the most important being the Llurimagua mining project, which is developed jointly with Codelco. The Minister of Energy and Non-Renewable Natural Resources has mentioned that the project is in the process of the incorporation of a limited liability company to develop this copper deposit.

However, mining in Ecuador has been involved in several controversies as indigenous, environmental, and social organizations have challenged several concessions due to alleged breaches of the state's obligations to carry out prior consultation with indigenous communities. These organizations also have requested that the Constitutional Court allow public referendums to prohibit mining activities in several locations in Ecuador. However, the court has rejected all the requests, given that the organizatons failed to comply with all the formal requirements established in the legislation to perform a local consultation.

Additionally, the country's authorities have closed its mining cadastre since December 2017 due to a planning stage. Since then, the World Bank and the Inter-American Development Bank have been supporting Ecuador to fine-tune and streamline the cadastre. The Vice Minister of Mines announced the reopening of the cadastre for 2020, which will allow requests for and the granting of additional mining concessions and is expected to attract important stakeholders of the mining industry.

Currently, mining in Ecuador is facing challenges from social and environmental organizations related to the prohibition of mining activities in several locations in the country. However, the government has adopted several legislative measures to protect and encourage mining activities and investors, especially those related to tax incentives. ✖