[Kabar-indonesia] 1 of 2: Business Briefing: Indonesian Mining 2006

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-1 of 2-

Global Competition Review [London]
July 21, 2006

Getting The Deal Through: Business Briefing

Indonesian Mining 2006

Contributing Editor: Robert McDermott

Mining industry  

1. What is the nature and importance of the mining
industry?  

Indonesia is among the top 10 producers in the world
for gold, copper, nickel and tin. Its world-class
mines include Grasberg, Batu Hijau and Soroako. Active
mining companies include Antam, Freeport, Koba Tin,
Newcrest, Newmont and Timah. The country is a key
supplier of minerals and metals to Asia's leading
industrialised and industrialising nations. Mining is
a significant contributor to Indonesia's GDP and the
major contributor to the GDP of a number of its
provinces (Papua, Bangka-Belitung, West Nusa Tenggara,
Riau, South Sulawesi and North Maluku).

Indonesia is highly prospective geologically. But
exploration for minerals and mine development (in
particular of known nickel deposits) has been impeded
in recent years by legal uncertainties arising from
decentralisation, the prohibition by Law No. 41/1999
of open-cut mining in designated 'protected' forest
areas and illegal mining. In addition, proposed
reforms to mining laws and the possible end to the
country's long-standing Contract of Work regime have
eroded investor confidence.

Nevertheless, the Department of Energy and Mineral
Resources reported that investments in mining in 2005
under Contracts of Work were US$506.09 million, up
from US$323.78 million in 2004. The mining industry's
commodity export value increased from US$7,304 million
in 2004 to US$9,385 million in 2005 (including coal).

Legal and regulatory structure  

2. Is the legal system civil or common law - based?  

Indonesia has a civil law system, inherited from the
Dutch who governed portions of Indonesia from the
early 17th century until 1949. Indonesia's Civil Code
has not been substantially amended for over a century.

Regulation  

3. How is the mining industry regulated?  
   
The mining industry in Indonesia is regulated by
central, provincial, regional and municipal levels of
government. Mining rights or authorisations (known as
kuasa pertambangan or KPs) may be granted and
regulated at all levels of government pursuant to
centrally enacted mining laws and regulations and,
increasingly, regional regulations. Provincial and
regional governments have also begun to exercise their
perceived authority by attaching conditions to grants
of mining rights and imposing additional obligations
and taxes on their holders. These, and regional
regulations, may conflict with central laws and so be
subject to review and cancellation by the central
government (ie, the Ministry of Domestic Affairs).

Indonesia's mining laws also contemplate the granting
of mining rights under contracts (kontrak karya or
contracts of work, KK or COW) between government and
private sector contractors. COWs are in theory
'negotiated' but in practice have followed a series of
evolving standard form agreements (from the first,
through to the seventh, and perhaps the eighth
'generation'), all of which have been approved by
parliament and the president. But obtaining a new COW
is currently a complex and sometimes impossible
exercise.

The existing mining law (as described below) is
perceived to be inadequate in many ways. There is a
need to resolve jurisdictional confusion and more
fully define the environmental and reclamation
obligations of mining companies.

Since 1999, the Forestry Law has prohibited open-cut
mining in 'protected forest' areas (a catch-all
category applying to much of Indonesia's forested land
mass). The central government had enacted decrees and
regulations exempting contractors under 13 COWs, Coal
COWs and holders of KPs approved before the enactment
of the Forestry Law in 1999 from that Law's
prohibition of open-cut mining in protected forest
areas. The Forestry Law requires holders of KPs and
contractors under COWs or Coal COWs to nevertheless
obtain use and borrow approvals from the Forestry
Department under regulations that are aimed at
limiting the impact of mining operations on forested
areas. But the implementing regulation issued by the
minister of forestry, Regulation No. P-14/2006, sets
forth difficult requirements that are almost
impossible for such mining right holders to perform.
Regulation P-14/2006 appears to permit limited and
conditional use of forest areas for mining activities
in exchange for reforestation commitments in other
areas or compensation.

>From 1967 until 1999, Indonesia had a centrally
regulated mining law regime with an 'open-door' policy
for foreign investment in mining that was viewed as
attractive and reliable by international mining
companies. For foreign mining companies, the
foundation of reliability was the COW. Considered to
be lex specialis, it granted exclusive mining rights
to a corporate contractor over a defined, usually
extensive, area for a 30-year term.

The rights and obligations of government and
contractors under COWs are, when so stated, immune
from subsequent changes in law, royalties and tax
rates. Furthermore, unlike KPs, disputes between the
government and the contactor granted mining rights
under a COW (except for those concerning tax matters)
can be resolved through international arbitration.
Enforcement of arbitral awards may be assisted, as
Indonesia is a party to the New York Convention on the
Enforcement of Foreign Arbitral Awards.

In 1999, decentralisation and regional administration
laws (Law No. 22/1999 regarding regional government,
replaced by Law No. 32/2004) transferred substantial
authority over hardrock mining from the central
government level to provincial, regional and municipal
government levels. Further to Government Regulation
(GR) No. 75/2001, mining rights in the form of KPs may
be issued, administered and regulated at the central,
provincial, regional or municipal level, depending
primarily on whether provincial, regional or municipal
boundaries intersect the area in question. At the same
time, Law No. 25/1999 and 33/2004 confirmed
significant increases in the share of revenues
allocated to provincial, regional and municipal
governments from dead rent, tax and royalty payments
made by holders of mining rights.

GR No. 75/2001 also provided that COWs 'should be
stipulated separately' in consultation with the
People's Representative Assembly Parliament. Since May
2005, parliament has considered a new Mining Law. This
has effectively blocked consideration and issuance of
new COWs for the past seven years even though there
are a number of major international mining company
applicants.

Regulatory bodies  

4. What are the principal laws that regulate the
mining industry? What are the principal regulatory
bodies that administer those laws?  
 
Principal laws:

article 33 of the constitution of the Republic of
Indonesia of 1945; Law No. 11/1967 on Basic Provisions
of Mining, GR No. 32/1969, GR No. 79/1992 and GR No.
75/2001; and minister of energy and mineral resources
Decree No. 1614/2004) (collectively referred to as the
Mining Law);

GR No. 45/2003 on Tariffs of Non-Tax State Revenues
Effective Within the Ministry of Energy & Mineral
Resources (GR No. 45/2003);

Law No. 32 and 33/2004 on regional government;

Law No. 41/1999 on Forestry and Law No. 19/2004; and

Regulation P-14/2006 (the Forestry Law); and

Law No. 5/1960 on Basic Provisions of Agrarian
Principles (the Agrarian Law).

Principal regulatory bodies:

Minister and Department of Energy & Mineral Resources
(DEMR);

Minister and Department of Forestry; and

central (BAPEDAL) and regional environmental
authorities.

For centrally issued or agreed KPs and COWs:

Minister of Energy and Mineral Resources (MEMR); and

DEMR and the director general of mineral, coal and
geothermal resources (DGMCG), formerly known as
director general of geology and mineral resources
(DGGMR).

For KPs provincially, regionally and municipally:

governors of 33 provinces; and

regents (bupati) and mayors (walikota) of 428 regions
(kabupaten) and municipalities (kota).

Mineral resource and reserve classification systems  

5. What classification system does the mining industry
use for reporting mineral resources and mineral
reserves?  

The JORC Code and Guidelines for Reporting of
Identified Mineral Resources and Ore Reserves, a joint
initiative of the Australasian Institute of Mining &
Metallurgy, the Minerals Council of Australia and the
Australian Institute of Geoscientists through the
Joint Ore Reserves Committee, is widely used in
Indonesia.

Mining rights and title  

6. Who has title to metallic minerals in the ground?  

Under article 33 of the constitution of the Republic
of Indonesia, 1945, natural resources (ie, land, water
and natural riches contained therein) are to be
'controlled' by the state and made use of for the
people. As a result, the state (ie, the government of
the Republic of Indonesia) is deemed to have title to
minerals in the ground and to mined and processed
minerals and metals.

Parties granted mining rights under the Mining Law are
in effect 'contractors' of the government and do not
by virtue of holding mining rights acquire title to
minerals in the ground. Parties holding mining rights
for exploitation, transport and sale under KPs or COWs
are granted the exclusive right to sell and export
mined minerals and retain the proceeds of sale
(assuming royalties and other payments to the
government are made in a timely manner). Title is
acquired by a purchaser from the government in
accordance with agreements for sale and purchase
between the purchaser and the KP holder or the COW
contractor (in effect, acting as the government's
agent), or at the point of export.

Publicly available information  

7. What information/data is publicly available to
private parties who wish to engage in mining
activities?  

The central DEMR in Jakarta provides published
information about Indonesia's mining law regime but
such information is not comprehensive and may not be
up to date, especially with respect to regional
regulations.

The DEMR will, on the request of any party, and for a
fee, provide printed maps showing areas covered by
grants of mining rights to identified parties. These
maps may not be up to date nor include mining rights
granted by provincial governors, regents or mayors but
not yet reported to the DEMR. Failure to report,
however, does not invalidate a KP. Lack of
coordination amongst government levels can result in
overlapping grants and resultant uncertainty.

Geological information and data can be purchased from
the DEMR for a fee per hectare for areas not subject
to a currently valid grant of mining rights. Such
information and data has usually been generated by
prior holders of mining rights for the area in
question and provided as legally required to the DEMR.

Mining rights and obligations  

\8. What mining rights may private parties acquire?
How are these rights acquired? What obligations does
the holder of these rights have?  

Mining rights are granted pursuant to the issuance of
KPs (for smaller areas) and, in theory, COWs (for
larger areas) on a first come, first served basis.
Such rights give the holder or contractor the
exclusive authorisation to conduct mining activities
in a defined area within a certain period of time
subject to performance of specified obligations. The
holder of a KP or a contractor under a COW has a right
to keep and sell minerals mined in its KP or COW area
provided that dead rent, certain taxes and royalties
are paid. KP holders and COW contractors (to the
extent specified in COWs) are subject to generally
applicable laws, such as environmental and forestry
laws.

At present, COWs are unlikely to be approved until the
Mining Law is amended and such amendment retains the
COW as one means of granting mining rights.
Nevertheless, the process for obtaining a COW
continues to be initiated by an application for, and
issuance of, a preliminary investigation permit (SIPP)
or an exploration permit. Such permits are issued by
the central, provincial or regional levels of
government depending on the location of the area
covered by the permit. The holder of the permit may be
a foreign company. The holder has the right to request
a COW for such area or part thereof. The processing of
such requests involves obtaining approvals of the
DGMCG and all levels of government, negotiation of the
terms and conditions of the COW and tabling of the
proposed COW before parliament for its 'approval'. The
COW is signed for the government by the MEMR following
approval by the president. It is also signed by a new
Indonesian company formed by the permit holder and at
least one other party (both of which can be foreign
companies).

An alternative but little used way to obtain a COW by
foreign investor involves conversion of KPs to a COW.
This requires negotiations and approvals concerning
all levels of government and additional approvals of
the DGMCG, the Capital Investment Coordinating Board
(BKPM), parliament and the president (see MEMR Decree
No. 1614/2004).

Mining rights may also be acquired through direct
transfer of KPs by their holders to third parties
provided the transfer is first approved by the
granting authority. Mining rights granted to
contractors under COWs or of a contractor's interest
under a COW may be assigned and transferred to
qualified parties if such assignment and transfer is
permitted under the terms of the COW in question and
approvals have been obtained, both as may be required
under the COW (normally from the MEMR or DGMCG) and
under regional administration laws. Assignments of
mining rights have been approved as security for
project loans for funding mine construction. Obtaining
approvals can be a prolonged process and as a result,
transfers and assignments are relatively infrequent.

A simpler but indirect method of obtaining or rather
controlling mining rights is (subject to restrictions
on foreign ownership) by purchasing the shares of a
contractor under a COW or of its shareholders.

KPs may be granted by the regent or mayor if the KP
area is located entirely within a regency or
municipality. KPs may be granted by the provincial
governor if the KP area straddles two or more
regencies or municipalities within a province and
there is no coordination between the regents or mayors
concerned. KPs may be granted by the MEMR if the KP
area straddles two or more provinces and there is no
coordination between the governors concerned. The
authority of regents and mayors extends to four miles
offshore, of governors to between four and 12 miles
offshore and of the MEMR to KP areas more than 12
miles offshore.

KPs grant exclusive mining rights to the holder for
specified minerals or metals, stages of mining
activity and specific time periods within a defined KP
area. However, a holder of a KP for exploration of a
specified mineral has a priority in applying for a KP
for other minerals discovered in the same area.

The holder of a general survey KP has priority over
other applicants for an exploration KP within the same
area. The holder of an exploration KP has priority
over other applicants for an exploitation KP within
the same area. Applications for later stage KPs and
extensions must be initiated during the term of an
existing KP.

COW contractors that are PMA (foreign capital
investment) or PMDN (domestic capital investment)
companies normally have special privileges or
concessions confirmed in the COW, for example, with
respect to duty-free import of capital equipment,
unrestricted export of mineral products and exemption
from currency exchange control if ever adopted by the
government. COWs may also establish special tax
regimes for the COW contractors and fix corporate tax
rates at the then current rate, with the government
undertaking to hold that rate for the life of the COW
and in some instances to give the COW contractor the
benefit of any future lower rate.

Some COWs require COW contractors to 'work towards and
assist' the government in establishing
metal-processing facilities in Indonesia, if
economically feasible. If such facilities have been
established in Indonesia by other parties, the COW
contractor may be required to process its mineral
products at such facilities if terms and conditions no
less favourable than offshore alternatives can be
obtained.

Mining-related obligations of a holder of mining
rights are set forth in the Mining Law, for KP holders
as conditions attached to the KP permit and for COW
contractors as terms and conditions in the COW. Other
obligations are imposed in environmental and forestry
laws.

To apply for and then maintain a KP or COW in force,
the holder or COW contractors must pay prescribed
deposits, dead rent, exploration or other
contributions, and land and building tax to specified
government authorities.

Work must commence within six months from issuance of
exploration KPs, within six months for
pre-exploitation work under exploitation KPs and
within one year for exploitation work under
exploitation KPs. A six-month hiatus when no work is
carried on can result in the KP being deemed
abandoned. Failure to comply with such deadlines, work
obligations and permit conditions can result in KPs or
COW companies being terminated. An issuing authority
may suspend performance of obligations due to force
majeure or other unexpected events.

Holders of mining rights are entitled to conduct
exploration, construct required infrastructure and
carry on other mining activities using proper mining
techniques and equipment. But holders must at the same
time acquire consents, relinquishments or transfers
from surface rights holders (see below). Holders are
required to deposit reclamation funds.

KP holders must submit preliminary reports detailing
mining plans, production targets and quarterly and
annual reports in a prescribed form.

The obligations of COW contractors are more extensive
and spelled out in detail in the COW. Special
obligations of COW contractors include, without
limitation, obligations for employment and training of
Indonesian nationals, maximisation of regional
economic and social benefits, regional and local
business development (with regional and local levels
of government involved in the programme and budgeting
process), providing public access to and use of
infrastructure, such as airstrips, harbours, roads and
bridges and payment of regional and local government
levies and taxes as approved by the central government
as such existed on the date of signing of the COW. The
decentralisation and delegation of authority to
regional has resulted in attempts by such levels to
collect additional levies when authority to do so may
be questionable or lacking.

COW contractors are obligated to sell mineral products
at arms' length international prices, report sales
revenues and justify sales prices.

Government approvals are required as a COW advances
from general survey through to exploration,
feasibility study, mine construction and finally to
the 30-year operating period. Mine and infrastructure
plans are also subject to government approval. Since
regionalisation, this means in practice approval by
all levels of government in the affected area.

Under certain COWs, PMA contractors and their foreign
shareholders are obligated to offer shares for sale in
the COW contractor to Indonesian nationals and
companies owned by Indonesian nationals. These COWs
specify the extent of such offerings and the
percentage of shares in the COW contractor company
involved. For some COWs, such offerings must continue
until such Indonesian parties own no less than 51 per
cent of all shares of the COW company. Offering prices
are specified as being 'fair market' prices but in
practice are the prices as agreed between the COW
company and the central government.

Since the enactment of GR No. 20/1994 and GR No.
83/2001, the mandatory level of Indonesian ownership
in a COW PMA company has been reduced to nil on
formation and some level (probably a nominal
percentage) after 15 years of production. COWs issued
thereafter have referred to GR No. 20/1994 as being
'at all times' (ie, for the life of the COW) the
governing requirement for Indonesian ownership of COW
contractor companies.

Domestic and foreign owned mining rights  

9. Is there any distinction between the mining rights
that may be acquired by domestic parties and those
that may be acquired by foreign parties?  

Under the Mining Law, KPs can only be granted to
Indonesian individuals and legal entities. Although
the Mining Law contemplates that the KP holder has a
demonstrable capacity to exploit minerals in its KP
area, this is often not the case. As a result, KP
holders on occasion enter into agreements with foreign
mining companies to carry out mining activities on
their behalf. Some KPs contain conditions requiring
approval of such agreements (sometimes referred to as
'cooperation agreements') by the issuing authority.

A foreign individual or entity cannot be a direct
party to a COW but can be a shareholder of an
Indonesian PMA COW contractor company. As mentioned
above, and subject to the terms of the COW in
question, foreigners can hold as much as 100 per cent
of the issued shares of such companies for 15 years.
Thereafter, a nominal percentage of shares in the PMA
COW contractor company must be offered to Indonesians
at fair-market or agreed prices.

Protection of mining rights

10. How are mining rights protected?  

KP holders and COW contractor companies may attempt to
enforce mining and related rights against third
parties in the Indonesian courts. Litigation is slow
and costly, judicial processes are cumbersome and
outcomes are difficult to predict.

As mentioned above, COW contractors have the
additional right of being able to resolve disputes
about their COW rights and the government's COW
obligations by arbitration. COWs contain arbitration
provisions of disputes and specify applicable
arbitration rules. The arbitration location may be
offshore if so specified in the COW or the initiating
party. Enforcement of an offshore arbitration award
may be facilitated given Indonesia's adherence to the
New York Convention on Enforcement of Foreign Arbitral
Awards. Enforcement, in any event, is likely to be
difficult and slow.

Indigenous people and their aaffect on mining rights  

11. How do the rights of aboriginal, indigenous or
currently or previously disadvantaged peoples affect
the acquisition or exercise of mining rights?  

Indigenous people are not recognised constitutionally
or otherwise as having any legal rights to mineral
deposits. Ownership of metals and minerals in the
ground is vested in the state, as described above.
However, local people and cooperatives are in theory
to be given priority in the event of competing
applications for KPs. In practice, a 'first-come,
first-served' approach may preclude this priority from
being exercised.

Surface rights  

12. What surface rights may private parties acquire?
How are these rights acquired?  

The holders of mining rights have the right to enter
and remain in the area covered by such rights in order
to exercise their mining right subject to acquisition
or relinquishment of surface rights held by other
parties. Surface rights may be based on customary law,
use or occupation and titles granted pursuant to the
Agrarian Law.

Holders of mining rights must negotiate and pay
compensation mutually acceptable for surface rights
and crops, trees and other plants of commercial or
subsistence value. Holders must also pay for affected
buildings and resettlement if necessary. Some COWs
provide that such compensation for surface rights is
to be 'reasonable' but expectations can cause
negotiations to be difficult and protracted. Regional
and local officials may assist in the acquisition of
surface rights, but there are no compulsory
acquisition laws or administrative tribunals empowered
to fix compensation.

The Agrarian Law established nine land titles, of
which three are relevant to the acquisition of surface
rights by holders of mining rights, namely:
right of ownership (hak milik);

right to build (hak guna bangunan - HGB); and

right to use (hak pakai).

Companies holding mining rights may obtain HGB and hak
pakai titles (which have a defined term of years) and
would normally do so for areas of land on which
plants, fixed equipment and infrastructure are to be
located. Hak milik may only be granted to Indonesian
individuals and certain entities but a hak milik
holder can relinquish his rights and allow conversion
of the title to HGB issued in the name of the mining
rights holder. Laws and procedures governing the
acquisition of land titles are complex and the process
can be lengthy.

Duties, royalties and taxes  

13. What duties, royalties and taxes are payable by
private parties carrying on mining activities? Are
these duties, royalties and taxes revenue-based or
profits-based?  

A holder of mining rights is required to pay the state
dead rent, royalties during exploration and
exploitation and other payments related to mining
activities and the area covered by the holder's mining
rights as may otherwise be required by law.

GR No. 45/2003 specifies the dead rent and royalty
obligations of KP holders. COWs specify such
obligations for COW contractors and these may differ
from those set forth in GR No. 45/2003. DGGMR Circular
Letter No. 008.E/84/DJG/2004 provides instructions for
calculating payments of dead rents and royalties. Law
No. 25/1999 specifies to which level of government KP
holders and COW contractors are to pay royalties and
how such levels of government are to allocate and
transfer these funds to other levels of government.

Dead rents are charged based on the number of hectares
covered by a KP or COW and the stage of mining
involved. For KPs, dead rent charges begin at 500
rupiah per hectare per year during the General Survey
and Preliminary Investigation KP and increase to as
much as 25,000 rupiah per hectare per year during the
Exploitation KP. For COWs, dead rent charges begin at
US$0.05 and increase annually to as much as US$4.00
per hectare per year.

Royalties for KP holders and COW contractors not
otherwise governed by royalty rates specified in their
COWs are defined as percentages (3 per cent to 5 per
cent) of FOB sales prices per ton or kilogramme of
metal exported as such or as contained in exported
concentrates.

Companies holding KPs also pay corporate income tax at
generally applicable rates (currently 30 per cent) and
are subject to generally applicable tax laws. COW
contractors pay corporate income tax at rates
specified in their COWs that may be more or less or
the same as generally applicable rates. COWs have
customarily contained special tax provisions for COW
contractors that constitute a special tax regime for
the life of the COW. Tax officials may not at times
respect the lex specialis nature of such provisions.

Tax advantages/incentives
 
14. What tax advantages/incentives are available to
private parties carrying on mining activities?  

Few special tax advantages or incentives are available
to holders of KPs. However, KP holders are eligible
for relief (in the form of a reduction to a maximum of
5 per cent) for a two-year period from import duty
imposed on machinery, goods and materials. Mining
services companies are also eligible for such relief
(minister of finance Decree No. 135/KMK.05/2000 and
Decree No. 28/KMK.05/2001).

PMDN and PMA companies holding mining rights either as
KP holders or COW contractors are eligible for relief
or exemption from duties on imported capital
equipment.

COW contractors may also be eligible for other
preferential tax treatments if contained in the
provisions of their COWs. For example, a COW
contractor may be eligible for a reduced rate of
withholding tax on dividend payments made to a foreign
shareholder if so provided in its COW.

Distinctions between duties, royalties and taxes  

15. Is there any distinction between the duties,
royalties and taxes payable by domestic parties and
those payable by foreign parties?  
 
Please see question 14, having regard to the fact that
KP holders must be Indonesian nationals or entities
owned by Indonesian nationals whereas COW contractors
may be Indonesian companies owned by foreign
shareholders. 

Business structures  

16. What are the principal business structures used by
private parties carrying on mining activities?  
 
Mining activities in Indonesia are normally carried on
by Indonesian limited liability companies (PT
companies) formed under the Company Law. Foreign
parties may only participate in mining activities as
shareholders of PT PMA companies as indicated above. 

Financing 

17. What are the principal sources of financing
available to private parties carrying on mining
activities? What role, if any, does the domestic
public securities market play in financing the mining
industry?  

There are few Indonesian sources of financing for
private parties carrying on mining activities.
Exploration funds tend to be raised through offshore
stock offering of listed affiliates of COW contractors
or parties with cooperation or similar agreements with
KP holders. Such funds are then lent to the mining
rights holder. Offshore banks have provided limited
recourse project finance loan facilities for mine
development and construction. Although several mining
companies are listed on Indonesia's stock exchanges,
the Indonesian public securities market does not play
a significant role in financing mining activities.

Restrictions and limitations  

18. What restrictions and limitations are imposed on
the import of machinery and equipment or services
required in connection with mining activities?  

There are no material restrictions or limitations of
any kind imposed under Indonesian law in connection
with the importation of machinery and equipment
normally required for mining activities. Normally
required services for mining activities may also be
obtained and provided in Indonesia. But the
'importation' of such services is closely regulated to
the extent that individual or corporate service
providers establish a physical presence or are deemed
to have a permanent establishment for tax purposes in
Indonesia.

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