The concept of free carried interest and state participation in Tanzania's mining sector

The mining sector is one of the most regulated sectors in Tanzania. Mining activities are primarily governed by the Mining Act, Cap 123 R.E. 2019 (as amended) (the Mining Act) supplemented by various regulations made under the Mining Act. Participation in mining activities in Tanzania is limited to individuals or entities that hold a valid mineral right over a respective area. Minerals rights include prospecting licences, mining licences and special mining licences depending on the intended activities and the capital injected.

There have been significant changes in the mining sector over the years, however, one of the most significant implemented change is the direct involvement of the Government of Tanzania (GoT) in mining activities effected through the Mining (State Participation) Regulations G.N. No. 574 of 2022 (as amended) (the State Participation Regulations). The State Participation Regulations apply to every mining company or person holding a mining licence or a special mining licence. The effect of the State Participation Regulations is to allow the GoT to participate in mining activities through holding free carried direct equity interest in any mining venture including mineral extraction.

In this month’s legal update, we analyse the concept of free carried interest and state participation in the mining sector.

Key Interpretations

The following key terms have been defined in the Mining Act and the State Participation Regulations which are applicable to this legal update:

“Free carried interest” means the interest derived from holding shares of which the holder enjoys all the rights of a shareholder but has no obligation to subscribe or contribute equity capital for the shares;

“Government Shareholder” means the Treasury Registrar or a company established or designated as such to hold GoT shares in accordance with the State Participation Regulations (in practice this is the Treasury Registrar);

“Mineral” means any substance, whether in solid, liquid or gaseous form, occurring naturally in or on the earth, or in or under the seabed formed by or subject to a geological process, but does not include petroleum or surface water;

“Mineral rights” means prospecting licences, retention licences, mining licence and special mining licence; and

“Mining licence” means a mining licence for medium scale mining operation, whose capital investment is between US$ 100,000 and US$ 100,000,000 or its equivalent in Tanzanian shillings;

“Special mining licence” means a licence for large scale mining operation, whose capital investment is not less than US$ 100,000,000 or its equivalent in Tanzanian shillings.

Free Carried Interest

From a practical perspective, free carried interest entails holding shares in a company without contributing financially for the shares. Under such an arrangement, the holder enjoys all the rights of a shareholder, including dividends. The State Participation Regulations entitle the GoT through the Treasury Registrar to hold not less than 16% non-dilutable free carried interest shares in the capital of a mining company holding a mining licence or a special mining licence.

The GoT is entitled to acquire, in total, up to 50% of the shares commensurate with the total tax expenditure in favour of the relevant mining company by virtue of section 10(2) of the Mining Act. Please note that the negotiations on whether to issue 16% or more shares in a mining company shall consider the extent of GoT development of public infrastructure servicing the mining venture or any specific infrastructure put in place by the GoT to enhance feasibility of the mining venture.

Acquisition of shares by the GoT under the State Participation Regulations shall be determined by the Mining Commission (the Commission) in consultation with the GoT shareholder and the Tanzania Revenue Authority. This will depend on the type of minerals under the relevant licence and the level of investment. Furthermore, the level of investment is determined by the Commission and in doing so, the Commission shall take into account the following factors:

1. capital invested;
2. mining technology involved;
3. profit; and
4. the total value of tax expenditures enjoyed by the mining company.

Mining Joint Venture Arrangements

In accordance with the State Participation Regulations, mining companies holding or those applying for a mining licence or a special mining licence are required to enter into joint venture arrangements with the GoT governed by a Framework Agreement substantially in a form set out under the First Schedule to the State Participation Regulations (the FWA). The FWA shall be negotiated between the GoT (through the Government Negotiating Team) and the relevant mining company in accordance with the Mining Act and the State Participation Regulations.

Furthermore, the relevant mining company will be required to enter into a shareholders’ agreement (SHA) with the GoT which will provide for the management of the joint venture company (JVC). It should be noted that a standard joint venture incorporated in Tanzania is not mandated to have an SHA (although it is advisable). However, this is a mandatory requirement when it comes to joint venture arrangements with the GoT in the mining sector.

The FWA provides that management of the JVC shall be governed by the SHA, a template of which is provided under the Second Schedule to the State Participation Regulations. The SHA sets out the composition of the JVC board of directors to be five (5) directors, two (2) of which shall be appointed by the GoT. Furthermore, the chairman to the board of directors shall be appointed by the mining investor and chosen among the directors appointed by the mining investors.

The joint venture arrangement between the GoT and a mining company shall be governed by the following principles (among others):

1. incorporation of a joint venture company between the GoT shareholder and the private investor. This essentially means that a mining joint venture is required to have the GoT as a shareholder, otherwise it will not qualify as a joint venture agreement stipulated under the State Participation Regulations;
2. the principle of equitable economic benefits sharing shall apply throughout the life of the mine;
3. having a jointly agreed financial model to guide the management and operations of the joint venture company. Please note that this model shall be substantially in a form set out under the Fourth Schedule to the State Participation Regulations;
4. jointly managing the JVC pursuant to the SHA;
5. agreeing on the fiscal assumptions underlying the economic benefits sharing principle;
6. joint venture company to hold all proceeds from sale of mineral products in local and foreign currency bank accounts in Tanzania; and
7. preference of Tanzanians for appointment to management positions in compliance with local content requirements.

By virtue of holding the free carried interest shares, the GoT shall be entitled to the following rights:

1. issuance of share certificate;
2. entry into the register of members of the relevant mining company;
3. participation in the mining company’s statutory meetings with rights to vote;
4. participation in the governance of the mining company;
5. access to reports relating to accounts, director’s and auditor’s report;
6. receiving dividends;
7. appointment of two (2) suitable persons, with pertinent qualifications as independent members to the Board of Directors of the company who shall represent the GoT’s interests;
8. participation in assets distribution on winding up;
9. participation in the removal of directors;
10. automatic allotment of free carried interest shares without financial contribution thereto;
11. actual ownership of free carried interest shares; and
12. receiving distributions made by the company, including loan notes in respect of qualifying shareholder loans.

Loan Notes

With regard to point l) above, regulation 8 of the State Participation Regulations provides for the following rules which will apply for the purpose of determining the right of the GoT to receive loan notes:

1. any shareholder loan which does not bear interest can be made without any obligation to issue loan notes to the GoT;
2. any shareholder loan which bears interest shall be subject to the obligation to issue loan notes to the GoT representing a percentage of free carried interest shares therein;
3. any shareholder loan raised from an external third party for the purpose of on-lending the funds to the JVC shall be subject to the obligation to issue loan notes to the GoT representing a percentage of free carried interest shares therein; and
4. any shareholder loan agreed by the parties which bears a reasonable interest rate that is advantageous to the JVC, shall not be subject to the obligation to issue loan notes to the GoT.

It is important to note that the phrase “reasonable interest rate” has not been defined in the legislation.

Default and Penalties

Section 63 of the Mining Act provides for instances where a mineral right may be suspended or cancelled. According to this section, the Commission may suspend or cancel a mineral right where the holder of a mineral right fails to comply with any requirement of the Mining Act or its regulations which are binding upon them. Please note that the Commission shall be prevented from suspending or cancelling a mineral right licence unless the following conditions are met:

1. the Commission has served a default notice on the mineral right holder outlining the grounds on which the licence is liable to suspension or cancellation;
2. the licence holder has failed to remedy the default within thirty (30) days of receiving the default notice or such longer period as may be prescribed. In the event where the Commission is of the view that the default is incapable of being remedied, the Commission may direct for the licence holder to pay reasonable compensation. Under such circumstances, the Commission will be mindful of whether such compensation has been paid within the prescribed period prior arriving at a decision to suspend or cancel a licence; and
3. the matter has been referred to the Commission for advice.

Conclusion

With the coming into operation of the State Participation Regulations, a requirement was imposed on holders of mining licences and special mining licences to notify the Commission of their intention to negotiate with the GoT to enable the GoT to receive their free carried interest. The time frame to notify was within ninety (90) days of publication of the State Participation Regulations which expired on 23 December 2022.