- Background information of First Majestic's dispute with the Mexican SAT.
- Details from First Majestic's most recent press release.
- I share my opinion on if this changes my view of First Majestic's investment prospects.
I recently wrote an article about the case for First Majestic (NYSE:AG) and using AG to bet on rising silver prices. You can find that here. Although I was bullish on First Majestic from a fundamental perspective on everything from their mining prospects to their financial performance to prospective silver prices, I overlooked the current ongoing legal dispute they have with the Servicio de Administracion Tributaria which is the equivalent of the USA’s IRS. Here I provide some background information on the dispute and how I’m thinking through this as an investor in First Majestic.
Primero (whom First Majestic acquired in May 2018) acquired the San Dimas Mine in 2010 and had a purchase agreement with Wheaton Precious Metals (WPM) where they would be required to sell 100% of the silver produced to WPMI up to 6,000,000 ounces and 50% thereafter for the lower of the spot price or $4.04 per ounce to increase 1% annually.
Since the price of silver was greater than 4.04/oz while Primero was operating the mine, they paid taxes on the income received from the mine based on the 4.04/oz price rather than the spot price.
Here’s the statement from First Majestic’s financial statements:
To obtain assurances that the Servicio de Administración Tributaria ("SAT") would accept the PEM Realized Price as the proper price to use to calculate Mexican income taxes, Primero applied for and received an Advance Pricing Agreement (“APA”) from the SAT. The APA confirmed that the PEM Realized Price would be used as Primero’s basis for calculating taxes owed by Primero on the silver sold under the Old Stream Agreement. Primero believed that the function of an APA was to provide tax certainty and as a result made significant investments in Mexico based on that certainty. On October 4, 2012, Primero received the APA Ruling from SAT which confirmed the appropriate price for sales of silver under the Old Stream Agreement. Under Mexican tax law, an APA ruling is generally applicable for up to a five year period which made this ruling effective retrospectively from 2010 to 2014.
If the SAT wins the dispute, according to First Majestic, they would have to pay income taxes based on the production that was sold to Wheaton Precious Metals at the market price from 2010 to 2018. This would amount to $157 million dollars according to First Majestic’s estimations.
This would only be to 2018 when the San Dimas acquisition took place as First Majestic signed a completely different agreement with Wheaton Precious Metals at that time. The terms of the new agreement with WPMI are:
25% of gold production plus an additional amount of gold equal to 25% of silver production converted to gold at a fixed gold to silver exchange ratio of 70:1 from San Dimas, with provisions to adjust the gold to silver ratio if the average gold to silver ratio moves above or below 90:1 or 50:1, respectively, for a period of six months.
For each ounce of gold delivered, Wheaton International will pay to First Majestic a production payment equal to the lesser of US$600/oz, subject to a 1% annual inflationary adjustment, and the prevailing market price.
First Majestic is not currently recording any liabilities on its financial statements related to the current dispute. According to their third party advisors, which I assume may be some combination of legal and accounting professionals, they do not believe there’s any reason to record this as a liability at this time. On the other hand, if they were to record a liability for this, it could potentially embolden the SAT to believe they would successfully win the dispute. So I’m not sure I would take this as a positive sign one way or the other.
First Majestic is, however, recording their income taxes receivable in the amount of $15.7 million as a long-term asset as they anticipate this dispute taking longer than one year. In the meantime, Mexico has determined not to deliver First Majestic’s income tax return until the dispute is resolved.
In its latest press release, First Majestic reported that they will be appealing to double taxation treaties which Mexico has entered into with Canada, Barbados, and Luxembourg which potentially makes First Majestic’s case. Here’s a portion of the full press release.
While the Company has made several attempts to seek to resolve its differences with the SAT using both local administrative and legal procedures and those contained within the treaties for avoidance of double taxation, and as well through diplomatic discussions, all such efforts have been met with actions of SAT intended to intimidate the Company, its subsidiaries and its employees, including notifications to Primero to secure amounts it claims are owed pursuant to its reassessments issued in violation of the terms of the Advance Pricing Agreement. These notifications impose restrictions on Primero’s ability to deal with its fixed assets until this matter is resolved.
My Question And Take On The Matter
My main question in all of this is, since First Majestic paid the taxes on the income from selling the silver at the $4.04/oz set price from the WPMI agreement, did Wheaton pay taxes on the difference between the $4.04/oz and the market price? Or was Wheaton taxed for its revenue/income in the United States? I’m not familiar with Mexican tax law but would assume if Wheaton paid tax also, that would be double taxation and it would make First Majestic’s case easy to make. The scenario was not made clear in First Majestic's financial statements. In the case of First Majestic’s most recent press release, it mentions double taxation treaties which makes me think this may be the issue at stake.
If First Majestic loses this battle, it will likely cost them above the $157 million estimate put out by First Majestic due to interest, penalties, etc. This would be a very substantial hit to First Majestic as this amount is greater than one entire year of operating cash flow. However, it would be a one-time expense, and once paid, investors could go back to valuing the company based on its prospective future cash flows.
With that said, I’m comfortable saying that First Majestic is still a really good way to play the prospect of rising silver prices. As I showed in my previous article, a marginal rise in silver prices would significantly increase operating cash flow. I don’t like to be overly optimistic, but as I heard one person say, this whole deal sounds like a good old-fashioned shake-down from the Mexican tax authorities. As a final word, I'm open to other ways to bet on silver and will be doing research in the coming days but still prefer First Majestic.
Lastly, I’m in the process of understanding the different jurisdictions for precious metal mining companies and would love to understand if anyone remembers Mexico treating other precious metals mining companies in this way. If you do, please leave a note in the comments below.
This article was written by
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