World Bank Institute - in cooperation with the Poverty Reduction & Economic Management/Public Sector Division : World Bank Institute - in cooperation with the Poverty Reduction & Economic Management/Public Sector Division Taxation of Natural Resources
Workshop on issues in revenue administration,
tax compliance, & combating corruption
M Grote
Tax Specialist
South African National Treasury
March 2 - 4, 2006, Cape Town, Republic of South Africa
Contents : Contents Natural Resources Taxation Principles
Economic Pressures on Taxation of Resource Rents
Growing & diverse number of stakeholders seeking sharing rights in mining projects’ resource rents
Balance of power between govt. & investors
Combination of fiscal charges
International Practices
Combined Marginal Tax Rates
Fiscal measures to preserve mineral wealth after depletion of natural resource deposits
Mining tax decentralisation vs. tax sharing
“Resource Curse: - transparency & accountability for mineral taxes
Natural resource taxation principles – key messages : Natural resource taxation principles – key messages Current trends in mining tax policy design indicate lowering of rates
Mineral royalty is consideration or lease payment for mineral extraction
Given declining real price trends for most energy & mineral commodities ― until fairly recently (2001/2002↑) ― internationally profit tax rate levels accommodated firms’ relatively low rates of return with profit tax rates converging around 30% to 35% level
Most jurisdictions employ combination of profit-based taxes with production taxes/ad valorem royalties, imposed at moderate rates (2% to 5%)
Characteristics of natural resource exploitation & its impact on tax policy design : Characteristics of natural resource exploitation & its impact on tax policy design Potential for huge rents
Volatility of commodity prices – structural change surprises
Enclave status of mines & processing facilities
Potential for overinvestment into supporting infrastructure
‘Politically motivated’ downstream beneficiation of minerals domestically extracted vs. creating functional markets
Ad hoc changes to fiscal regime if ‘windfall’ profits arise
Creating power base for elite, thereby encouraging corruption
Will preventive measures be taken by Government in expectation that deposits will be ultimately depleted?
Lack of transparency & accountability regarding tax proceeds
Tendency to prescribe price controls for domestically produced mineral resources (especially in case of oil & gas)
Trend to introduce state enterprises vs. leaving it to market
Environmental degradation, compensating for neg. externality
These factors led to “Resource Curse” theory
Specific nature of resource taxation : Specific nature of resource taxation In some developing countries mining/hydrocarbon sector dominate economy
Mining & hydrocarbon sectors have potential to develop into major revenue source
Huge challenge to develop appropriate fiscal regime that could capture for governments significant share of economic/resource rents
Balance short-term revenue needs against long-term attractiveness of jurisdiction as FDI destination ― its all about risk sharing between govt. & investors
Common tax treatment for both hard-rock mining & hydrocarbon extraction will be presented
Historic trends of resource taxation : Historic trends of resource taxation For centuries royalties (specific & ad valorem) formed backbone of mineral taxation ― until 1950s
Since 1950s combination of fiscal instruments:
royalties & ordinary profit taxes
Since 1970s & 1980s (OPEC era) increasing fiscal burden on mineral sector (especially oil & gas)
More direct involvement by governments into raising their share of economic rents through introduction of production-sharing contracts, equity participation (has contract-stability enhancing outcome as automatically shares in windfall profits)
Need to attract FDI through rolling out tax expenditures/tax incentives
Key policy question: Are tax incentives needed?
FDI – Global & Africa specific features : FDI – Global & Africa specific features Global FDI flows have been under pressure due to global economic slowdown
Uncertainty with regard to mineral property rights & public policies in Africa had further negative impact on FDI into minerals sector
Africa’s share in global FDI is mediocre
Regional trading blocks dominate FDI flows
Africa is treated differently – political strife, dysfunctional infrastructure
SADC seeks to address this problem area
Most FDI to SA driven by domestic market share
Emphasis on domestic growth & demand, rather than global competitiveness
Small market size presents limit to potential FDI flows
SA’s FDI flows stagnant in US$ terms since 1994
Once-off flows in 2005 only source of increase
FDI - Role of tax policy : FDI - Role of tax policy It’s about policy credibility & perceptions, not (quick fix) incentives
Irreversibility of FDI requires long-run policy commitment
Emphasis on providing long-run signals & certainty over tax legislation
Success of tax policy cannot be measured by its short term impact
Need to ensure limited transaction costs (e.g., senseless overregulation, see World Bank’s Doing Business in 2004, understanding regulation
Long-run signals: tax policy support developmental goals
Need to replace exchange controls by inducing voluntary change in behaviour through assuring tax measures
Tax policy complementary to overall economic policy
Tax policy programme is element of public policy choices which should address determinants of investment returns
Enhancing investment returns by following govt. interventions (ranked in order of priority): : Enhancing investment returns by following govt. interventions (ranked in order of priority): Improve infrastructure in transportation, communication, energy & water
Lowering duties & barriers on international trade → improved access to wider regional markets
Firmly committed to macroeconomic stability
Investing in health and education services
Eliminating excessive red-tape through deregulation, procedural simplification & civil service reform
Establishing effective laws & institutions to control corruption
Strengthening institutions to protect property rights, enforce contracts & control crime
Establish attractive tax laws with moderate effective tax rates
Providing special fiscal investment incentives which constitute tax breaks, direct grants/subsidies, additional deductions for wages, BUT maximise certainty, stability & predictability
Negotiating fiscal regime – fluctuating balance between governments & investors : Negotiating fiscal regime – fluctuating balance between governments & investors INVESTORS ― prefer back-
end loading of tax payments:
Attractive / low burden fiscal measures to compensate for project & sovereign risk
Recoup initial capital outlay on mining, oil & gas projects over shortest time possible
Maximising long-run post-tax returns
Fiscal stability provisions – no windfall profit taxes when commodity cycle moving upwards
Preference for Rent Resource Tax or Brown Tax (negative tax or subsidy by governments)
GOVERNMENTS ― prefer front-end loading of tax payments:
Securing substantial share of resource rent
Minimising tax-induced inefficiencies
Receive fiscal revenues as production commences
Integrating most of tax elements of mining and oil & gas tax issues into general tax codes
Simplify tax administration & protect with appropriate anti-avoidance measures against transfer pricing practices
Minimise information asymmetry as to projects’ profitability
Is the world moving towards a “super commodity cycle”? : Is the world moving towards a “super commodity cycle”? Is negotiation balance of power swinging towards governments of resource-rich countries?
Will short-term policy objectives regarding fiscal revenues translate into renegotiation of fiscal contracts, with emphasis on additional profit or super-profit taxes?
Will existing bilateral investment treaties deem this as constructive expropriation?
Will this impact adversely on FDI into Africa ― long run effects?
Will windfall/super-profit taxes advance as 3rd element of resource tax combination in the case of minerals (it is already a feature of many hydrocarbon contracts)?
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
Recent economic pressures on profit tax rates : Recent economic pressures on profit tax rates
General principles in resource taxation Thomas Baunsgaard – Primer on Mineral Taxation, IMF WP/01/139 : General principles in resource taxation Thomas Baunsgaard – Primer on Mineral Taxation, IMF WP/01/139 Mineral extraction includes exploitation of hydro-carbons (oil, condensate, gas) & ‘scarce’ hard-rock minerals (gold, silver, PGMs, copper, iron ore but not sand & gravel)
Economics of extraction show commonality & therefore general taxation principles exist
But mineral deposits show huge grade/richness differences with deviating economic rent potential, which would justify deposit-by-deposit tax regime
Practically, case-by-case approach exceedingly difficult to achieve due to information asymmetry regarding deposits’ profit potential, informed by―
Differing grades, geographic distance to market, available infrastructure, cost of development, sovereign risk
General principles - continued : General principles - continued Hard-rock mining:
Artisan mining, may escape standard tax regime & may only attract licensing fees, royalties or surface fees
Small-scale mining
Large-scale projects may negotiate special tax allowance systems
Production-sharing agreements very rare
Oil:
Large oil/gas fields generate super rents, therefore royalties & other fiscal charges are commonly much higher than in mining (between 12.5% and 20%)
Size of oil field shows high correlation with profitability
Production-sharing contracts are common
Gas:
Not as profitable as oil as markets must be created
Frequently expensive pipeline infrastructure, cross-border problems, exceedingly expensive downstream liquefication & transportation
High political risks, therefore individually negotiated with very flexible fiscal regimes, e.g. Gazprom, Ukraine debacle, long-term negotiations for Mozambique’s Pande & Namibian Kudu gas fields
… and remember that tax is not neutral : … and remember that tax is not neutral
“All taxes are a drag on economic growth. It’s only a question of degree.”
“There’s only one way to kill capitalism – by taxes, taxes, and more taxes.” Alan Greenspan
Karl Marx
Why does tax design of natural resource sector deviate from other economic activities? : Why does tax design of natural resource sector deviate from other economic activities? Separate fiscal system for resources sector due to economic/resource rent potential which can be ascribed to scarcity of exhaustible resources (Hotelling rule, The Economics of Exhaustible Resources,1931)
Resource rents are surplus return over & above input costs (capital, labour, materials, other production factors, opportunity costs of sunk capital)
Resource rents are excess profits over minimum rate of return which is required to justify investment into natural resource exploitation
Pure rent represents surplus/financial return that could ALL be taxed away without influencing econ behaviour or distorting resource allocation
But is presupposes government’s perfect information on deposit’s profitability
Mining investments’ returns are unknown ex ante … : Mining investments’ returns are unknown ex ante … Mineral extraction projects deal with many uncertainties:
Geological, commercial, political changes
Investors being risk-averse & will invariably choose less risky one, out of 2 projects with same net present value
Investor will demand higher risk premium for riskier project
Higher risk premium increases supply price of such project ― through its influence on taxation, govt. can adjust by extracting smaller % of economic rent
Investors have therefore huge incentive to overstate project risk as negotiation tool
2 risks: project/commercial risk (information asymmetry as to profitability of deposit) & sovereign risk (affected by government actions)
But govt. can also reduce commercial risks – macro-econ. & fiscal stability, availability of exploration data, infrastr.
Types of resource taxes : Types of resource taxes No single best model of different tax combinations―
Model incorporating self-adjusting tax increases in times of high commodity prices, will guarantee stability of fiscal contract & increase country’s LT-attraction for FDI (certainty, predictability)
Direct tax instruments:
Corporate income tax
Progressive profit taxes such as gold mining formula
Resource rent taxes
Brown tax, cash flow tax with government subsidy
Windfall profits tax, additional profit tax, super-profit tax
Indirect tax instruments:
Ad valorem, specific/production volume royalties
Import duties
VAT
Non-tax instruments:
Competitive bonus bidding, auctions (e.g., hydrocarbons)
Surface fees
Production sharing contracts
State equity participation
Corporate tax - mining : Corporate tax - mining Most jurisdictions apply standard corp. rate
Higher corp. rate applies in case of hydrocarbons due to higher economic rent potential
Attraction: same admin practices, legal framework
BUT, due to resource deposit specificity, individually negotiated corp. tax dispensation may be applied for large-scale projects (deposit-by-deposit)
Dividend withholding taxes if distributed to non-residents
Other jurisdictions exempt mineral extraction activities from dividend withholding taxes due to higher overall tax rates on resource companies
Special capital allowances for capital intensive projects, mostly 100% expensing for exploration & development
Mining rehabilitation trust funds: deduction for contributions to fund & tax-free buildup of fund
Putting floor under corporate income tax : Putting floor under corporate income tax Transfer pricing incidence potentially high― requires introduction of OECD-type anti-transfer pricing rules & ring-fencing provisions:
TNCs dominate in mining & multi-jurisdictional operations enable them to exploit tax rate differentials
Inflating expenditure deductions via high-tax jurisdictions & record profits in low-tax jurisdictions by:
Sale of minerals below market prices to affiliates in low-tax jurisdictions (diamonds notoriously difficult to value – GDV) & not all minerals are traded on metal exchanges (vertically integrated firms)
Use of innovative price hedging mechanism between related parties
Debt finance provided by related parties at above-market interest rates
Related party excessive management fees, technical services, or HQ costs
Leasing arrangements for provision of capital goods & machinery
If mineral extraction attracts higher corp. rate – domestic shell firms provide finance capital to related parties, creating interest deductions at higher tax rate
REMEDIES: related party safeguard measures, arms-length pricing rules, capping of certain deductions, limit allowable debt of project
Corporate income tax―ring-fencing provisions : Corporate income tax―ring-fencing provisions Commonly, corp. income tax applies to consolidated group operations
In resource taxation, frequently individual deposits enjoy certain tax incentives which could erode wider tax base
Authorities introduce 2 kinds of ring-fences:
Ring-fencing mining from non-mining income
Ring-fence per deposit/project (see SA): without it firms can finance new developments against tax base of mines that have just become profitable after long lead times (tax deferral benefit)
Without ring-fence continuous deductions defer tax payments over long period (“tax deferred is tax foregone”)
Too tight ring-fence has economic inefficiencies (discourages exploration, capital deepening in economically less attractive deposit
Ring-fence in case of gas: entire up- & down-stream project
Progressive profit tax – e.g., SA gold mining tax formula : Progressive profit tax – e.g., SA gold mining tax formula Some jurisdictions introduce progressivity into CIT in anticipation that with higher commodity prices, government should participate in greater share of economic rent
Various methods:
Ad hoc graduated/stepped CIT rate linked to higher unit price of commodity, production volume (in case of oil approximation for higher profits), sales turnover or profit-to-sales ratio
Stepped rate structure not accurate proxy for varying rate of return
Monitoring comes at high administrative cost
Taxpayers have increased incentive to under-report income
SA gold mining tax formula with built-in progressivity, linked to level of profitability of gold mine – marginal mine taxed at 0%:
y = a-(ab/x), where
‘y’ = tax rate to be determined (sliding scale taxing higher profits at high rates)
‘a’ = marginal tax rate
‘b’ = portion of tax-free revenue
‘x’ = ratio of taxable mining income to total income (including non-mining income)
SA gold mining tax formula : SA gold mining tax formula 1966 gold mining formula had average tax rate spreads ranging from 0% to 70.5%. (unacceptable, as every $ of profit should attract income tax, but govt. created incentive to mine marginal ore)
Only taxable income exceeding 6% of profits attracted tax (i.e., tax free tunnel)
Currently, income derived from mining of gold is calculated according to following formulae (on basis of new 2005 corporate rate of 29%):
Y = 35 – 175/X (elected to be exempt from STC).
Y = 45 – 225/X (not exempt from STC),
where Y is the percentage tax payable and x is profit ratio of the mine, expressed as percentage.
Profit ratio (x) is calculated as follows: taxable income from gold mining over gross mining income.
Tax effect of gold mining formula: Y = 45-225/X : Tax effect of gold mining formula: Y = 45-225/X
Average tax rate on total income, once taxable income exceeds 5% tax tunnel ― Y = 45-225/X : Average tax rate on total income, once taxable income exceeds 5% tax tunnel ― Y = 45-225/X
Resource rent taxes (RRT) : Resource rent taxes (RRT) Attempts in 1970s (Garnaut & Clunies-Ross, 1975, 1983) to design ‘neutral’ tax burden, affecting only economic rent:
R-factor (investment-payback ratio―ratio of investor’s cumulative receipts over cumulative costs, incl. upfront investments).
Tax kicks in when R-factor greater than 1
Some production-sharing contracts include this progressive feature with growing government share as investment-payback ratio grows
Accumulated cash flows are not discounted
Resource Rent Tax is cash flow tax linked to real rate of return
Applies after hurdle real RoR on investment has been achieved
Hurdle real RoR equals supply price of investment/capital
RoR is often mark-up on rate of return of some other alternative safe investment (opportunity cost of capital)
Tax calculated by increasing annual cash flow (without deductions for interest cost & depreciation allowance) by hurdle RoR & continuously carry forward until it turns positive
Resource rent taxes - continued : Resource rent taxes - continued Cash flow in large projects is initially negative (US1-2 billion initial investment)
By increasing each acct. period’s cash flow with hurdle RoR (=real interest rate), real value of cash flow is maintained (investor’s discount rate must be equal to hurdle RoR)
When carried-forward cash flow turns positive, hurdle RoR has been achieved and RRT applies on profits above this threshold
RRT has been imposed with graduated rate structure to smooth in shift to more punitive tax regime
Very few jurisdictions have imposed this regime due to back-loaded nature of tax payment (governments bear all the cash flow risk)
Long periods of tax deferments could pose political risks as affected communities do not see improvement in services due to lack of public funds in start-up period
RRT only attractive in theory as it secures hurdle RoR for investor & allocates appropriate economic rent share to government
For less profitable projects government face risk of generating no tax income at all―whilst incurring huge outlays for establishing infrastructure for investor (all the risk is shifted to govt./ it sells off its minerals for free!)
Get real: RRT only as add. profit tax in combination with corp. tax or royalty
Brown tax, even more neutral : Brown tax, even more neutral Brown tax imposed at flat rate on annual net cash flow with immediate expensing of all capital expenditure
Negative net cash flow would not be carried forward at real rate of interest as in RRT, BUT would trigger subsidy payment by government to investor
Subsidy based on same flat tax rate
Unrealistic, as developing countries do not have cash flow
Brown tax absolute neutral but transfers all risks to governments
Governments would potentially face huge fiscal losses (negative tax) although not involved in mining operation
Will investor trust government in making good on its subsidy promise? (increased sovereign risk)
That is even worse than equity participation by government (on commercial terms as opposed to free equity)
It could trigger wasteful utilisation of capital by investor
Hence, universally rejected by governments
Indirect charges: royalties : Indirect charges: royalties Royalties oldest form of mineral extraction taxation & are imposed on value of mineral sales (ad valorem) or set charge per production volume (specific):
Favoured by governments due to front-end loading of tax payments
Factor payment/consideration for right to extract (similar to capital and labour input costs)
If imposed at too high rates, become deterrent to investment as increase economic cut-off grade of mineral deposit
Will make development of marginal deposit unprofitable
In case of oil/gas production royalties can be imposed on net of cost basis to accommodate for production & transportation cost
Some jurisdictions share royalty proceeds between central & sub-national levels of government (PNG, Indonesia)
Admin capacity must exist to monitor closely production volumes
In designing mineral royalties internalise certain government mineral policy objectives : In designing mineral royalties internalise certain government mineral policy objectives Royalty is consideration payable to state for right to extract mineral resources
It is analogous to lease payment: if lessee is operating unprofitably, lessor will not rent-out property for free
Since host country’s minerals & petroleum resources are non-renewable, these production factors cannot be disposed off for free
Mineral & petroleum resources belong to the nation (state is custodian)
Royalty design needs to create internationally competitive & efficient mineral & petroleum fiscal system
System must contain rules seeking maximum certainty & clarity for investor community
Ad valorem gross sales royalty vs. profit royalty : Ad valorem gross sales royalty vs. profit royalty Amount of ad valorem gross sales royalty is determined by applying consideration rate on gross sales value of minerals / petroleum
Royalty does not accommodate:
Differences in production costs of minerals
Differences in profit ratios from sale of minerals
In contrast, profit-based royalty focuses on investors’ after-cost profits from sale of minerals
Profit-based royalty base is narrower―hence, much higher rate structure needed (e.g., Canada)
Both gross sales royalty & profit-based royalty are deductible expenses for income tax purposes
Advantages of gross sales royalty : Advantages of gross sales royalty Companies cannot artificially inflate costs
Government faces therefore less collection risk
Royalty adjusts automatically for commodity price fluctuations & changing profitability: e.g., currency depreciation / declining profits in times of currency appreciation
Non-negotiable aspects of royalty has fiscally stabilising impact:
communities [could] see benefits of increased public resources as mineral production commences
Over long run should maximise investor certainty
Narrow compliance gap as administration is straight forward & predictable
However, fair market value must be ascertainable
Disadvantages of gross sales royalty : Disadvantages of gross sales royalty Base of royalty is broad ― relatively high rates may unduly erode investor profits
This type of royalty may encourage mining of high-grade ores ( “picking-the-eye” problem)
Command & control measures against ‘high-grading’ problem
Government needs advanced regulatory capacity to enforce mining of deposit to "average grade of ore"
Complexity arises in calculating composite minerals in concentrate rock form
Advantages of profit royalty : Advantages of profit royalty Profit royalty has minimal adverse impact on private investment behaviour because Government & investors are both proportionately at risk
It focuses on mine’s ability to pay (but it is a factor payment not a tax!)
Calculation of royalty does not require segregation based on mineral type, grade, or level of processing
One rate could be applied to all mineral categories
Disadvantages of profit royalties : Disadvantages of profit royalties Profit royalties may easily be subject to arm’s length pricing concerns & accounting manipulation, (inflating costs)
Comprehensive anti-avoidance measures are needed (similar to those in Income Tax Act)
Collection risk is high for government because royalties vary with profits
Risks to royalty regime – minimised by gross sales system but anti-avoidance measures still needed : Risks to royalty regime – minimised by gross sales system but anti-avoidance measures still needed “In mining and mineral processing output prices have to be thought of not as being independently determined, but as a mobile network linked to vertical and horizontal integration.
A vertically integrated producer can push prices up and down the chain to declare profits at various stages of the production process according to ownership, taxation and other conditions.” –
Hughes and Singh in Garnaut & Clunies Ross (1975: 280), ‘Uncertainty, Risk Aversion and the Taxing of Natural Resource Projects’
Royalty practices in “successful mining countries” : Royalty practices in “successful mining countries” Australia: accounting profits royalty (APR) imposed in Northern Territory (APR rate is 18%,):
Mining corporations with diversified portfolio of mining projects have ability to allocate overall amount of corp. debt to any given mining project of group.
Hence, mining houses are able to load mining projects with debt that are liable for APR, thereby wiping out APR liability entirely for years (revenue deferred for long is revenue foregone!).
APR regimes thus have to deal with complex income tax anti-avoidance issues (= tax depreciation allowances & rules about allowable interest & other cost deductibility).
Charging base is therefore narrower with commensurate higher rate structure (Head & Krever (eds.): Taxation towards 2000 – Australian Tax Research Foundation, p. 210)
Australia - continued : Australia - continued
APRs applied only in few specific instances & generally in combination with other royalty systems (specific & ad valorem) as defensive measure by government to secure greater share of resource rents.
“By far the predominant form of mineral taxation is the ad valorem royalty which simply takes a percentage share of the gross value of output from specified mining project” (B Smith in Head & Krever (eds.), p 210)
Ad valorem & specific royalties create least uncertainty for government revenue collections – involves greatest transfer of risk to mining companies
Western Australia – ad valorem royalty rates as on 1 January 2003 : Western Australia – ad valorem royalty rates as on 1 January 2003 Ad valorem or gross sales-based royalty calculated as proportion of ‘royalty value’ of mineral
‘Royalty value’ defined – “in relation to a mineral, other than gold, means ‘gross invoice value’ less any allowable deductions for that mineral”
‘Gross invoice value’ in relation to a mineral, means amount in A$, obtained by multiplying quantity of mineral, in form in which it was first sold … by mineral price
‘Allowable deductions’ means the amount of any costs in transporting the mineral … incurred after the shipment date
Gold – rate of royalty payable is 2,5% of value of gold metal
If average gold spot price for quarter is less than A$450 per ounce, rate of royalty payable is 1.25% of royalty value of gold metal produced
Western Australia – royalty rates as on 1 January 2003 : Western Australia – royalty rates as on 1 January 2003
Western Australia – royalty rates as on 1 January 2003, in Australian $/c : Western Australia – royalty rates as on 1 January 2003, in Australian $/c
Cross-country analysis of royalty regimes : Cross-country analysis of royalty regimes
Cross-country analysis of royalty regimes – African jurisdictions : Cross-country analysis of royalty regimes – African jurisdictions
SA proposed royalty rates (2003) : SA proposed royalty rates (2003)
International royalty rate (in %) comparisons across commodities : International royalty rate (in %) comparisons across commodities
International royalty rate (in %) comparisons across commodities : International royalty rate (in %) comparisons across commodities
International royalty rate (in %) comparisons across commodities : International royalty rate (in %) comparisons across commodities
International royalty rate (in %) comparisons across commodities : International royalty rate (in %) comparisons across commodities
Total Tax vs. Total Sales, in Rand : Total Tax vs. Total Sales, in Rand
Other indirect tax issues : Other indirect tax issues Import duties:
Tax neutrality principle suggests that resource sector should attract import duties as rest of economy
But many jurisdiction offer special exemptions due to huge start-up costs of key resource projects & as this kind of front-loaded revenue take is more aggressive than royalty payments
VAT:
Mineral exports of developing countries mostly exported (zero-rated in terms of standard destination-based VAT system)
Mines qualify for input credits, which could be huge & trigger major fiscal revenue transfers/losses for VATadmin (projects would be in constant VAT refund position), especially during start-up period
Could challenge weak VAT administrations to pay refunds in time
Many jurisdictions overcome refund dilemma by exempting from VAT imported capital equipment & other stores (pragmatic)
Needs careful monitoring as it opens loopholes exploited by unintended beneficiaries
Non-tax fees ― front-end loading favouring government as resource owner : Non-tax fees ― front-end loading favouring government as resource owner Fixed fees, prospecting/mining surface rental fees:
Administrative charges unrelated to profits but a function of size of area under license (more regulatory measure to make unaffordable the sterilisation of mineral deposits as anti-competition strategy by firms)
Competitive bonus bidding (petroleum sector) / discovery or production bonuses:
If there are sufficient number of competitors in bidding process for oil/gas leases, government could get up-front appropriate share of economic rent
If few players bid, risk of price collusion significant & government will not share sufficiently in economic rents of resource
Front-end loading may discourage marginal resource developt.
Needs little admin effort
In cases of uncertain geological potential & high sovereign risk, investors are loath to commit significant funds to governments & hence, bidding amounts may generally be too low
Could destabilise project over long run, as initial low bids for potentially lucrative resource may trigger re-negotiations of fiscal terms
Production sharing contracts (PSC) – oil & gas : Production sharing contracts (PSC) – oil & gas Ownership of hydrocarbon resource remains with government throughout exploitation period & company is contracted to develop resource
As consideration, co can retain share of production
Three generic types of production sharing:
Concession agreement
Production sharing contract
Risk service contract (contractor receives flat fee for services)
PSCs developed in Indonesia in 1960s, but now quite common in oil-producing countries (tax creditable if very similar to CIT):
LT arrangement between host govt., whereby investor takes on pre-production risk & recovers cost and profit share out of production
Profit oil is derived from gross production by deducting allowable production costs
Profit oil shared in pre-determined ratio between govt. & investor
PSCs can be graduated with rising shares to govt. as production volume, crude price or returns increase
Allowable production cost that can be claimed per acct. period can be capped & carried forward (period or unlimited) = equivalent to royalty
State equity in resource projects : State equity in resource projects Certain governments hold equity in resource projects (see diamond industry in Namibia, Botswana)
Thereby secure higher slice of economic rent in times of buoyant commodity prices (in lieu of super-profit tax & no retro-activity)
Could be stability-enhancing & prevent renegotiation of fiscal terms
For non-economic reasons: increase govt. ownership, tech-transfer, more direct control (in lieu of proper regulations?)
But equity can be costly for paid-up equity or cash-calls & conflict of interest as regulator (environmental, labour laws)
Investors prefer government’s role as regulator & tax collector
Equity participation in many forms:
Commercially transacted paid-up equity
Paid-up equity on concessional terms
Carried interest―govt. pays for it out of production proceeds
Tax exchanged for equity (reduced tax liability)
Equity in exchange for provided infrastructure
Free equity, less transparent as taxes may be offset
What combination of tax & non-tax instruments? : What combination of tax & non-tax instruments? Different combinations of taxes & fees can achieve desired economic impact
PSCs can be designed to mimic CIT plus royalty combination ― if it operates closely to CIT, even tax credits could be negotiated with investor’s home country
Paid-up equity is equivalent to a Brown tax with tax rate equal to share participation
Jurisdictions choose combination which can build on institutional memory of tax administration, informed by skills, HR capacity
Economic impact of resource taxes : Economic impact of resource taxes Economic theory strongly suggests that taxes impact adversely on resource allocation
Add to compliance & administrative burden
Difficult trade-off between revenue maximisation and mineral production inefficiencies (raised cut-off grades)
Resource taxes reduce RoR and impact negatively on exploration & investment
BUT taxes used as market-based instrument could force sustainable mineral development by internalising negative externalities stemming from environmental degradation
Comparative efficiency impact of resource taxes ― Baunsgaard (2001), Daniel (1995) & Garnaut and Clunies-Ross (1983) : Comparative efficiency impact of resource taxes ― Baunsgaard (2001), Daniel (1995) & Garnaut and Clunies-Ross (1983)
Fiscal stability clauses : Fiscal stability clauses Risks affect both investor & government
Investors are risk adverse BUT so are govt’s of LDCs
If govt. sees that taxes are deferred continuously, pressures for renegotiation grow
Hence, investors seek fiscal stability clauses
Perception of fiscal stability enhanced if tax measures are introduced that correlate tax take closely with RoR:
which favour progressive profit taxes,
RRT in theory and to lesser extent CIT or PSCs
Fiscal preservation clauses may initially appear attractive, but over long run prove to be very expensive as it limits govt. ability to change fiscal terms in face of ‘super profits’
Different forms of stability clauses:
Freezing rates and tax base definition
Administrative complex if per project as admin must keep separate track of agreements
Or guaranteeing investor share of economic rent
1997: wide-spread fiscal preservation in petroleum sector (out of 109 63% provided fiscal stabilisation for all taxes, 14% partial stab., 23% had none
2004/05 Cross-country tax rate analysis PriceWaterhouseCoopers Corporate Taxes – Worldwide Summaries & April 2005 NBER Working Paper on Developing Countries’ Tax Structures : 2004/05 Cross-country tax rate analysis PriceWaterhouseCoopers Corporate Taxes – Worldwide Summaries & April 2005 NBER Working Paper on Developing Countries’ Tax Structures
2004/05 Cross-country tax rate analysis PriceWaterhouseCoopers Corporate Taxes – Worldwide Summaries April 2005 NBER Working Paper on Developing Countries’ Tax Structures 2006 Index of Economic Freedom – Heritage Foundation & Wall Street Journal Deloitte.Touche – Guide to Key Fiscal Information, Southern Africa, 2005/06 : 2004/05 Cross-country tax rate analysis PriceWaterhouseCoopers Corporate Taxes – Worldwide Summaries April 2005 NBER Working Paper on Developing Countries’ Tax Structures 2006 Index of Economic Freedom – Heritage Foundation & Wall Street Journal Deloitte.Touche – Guide to Key Fiscal Information, Southern Africa, 2005/06
2004/05 Cross-country tax rate analysis PriceWaterhouseCoopers Corporate Taxes – Worldwide Summaries April 2005 NBER Working Paper on Developing Countries’ Tax Structures 2006 Index of Economic Freedom – Heritage Foundation & Wall Street Journal Deloitte.Touche – Guide to Key Fiscal Information, Southern Africa, 2005/06 : 2004/05 Cross-country tax rate analysis PriceWaterhouseCoopers Corporate Taxes – Worldwide Summaries April 2005 NBER Working Paper on Developing Countries’ Tax Structures 2006 Index of Economic Freedom – Heritage Foundation & Wall Street Journal Deloitte.Touche – Guide to Key Fiscal Information, Southern Africa, 2005/06
Risk of high marginal tax rate if combination of taxes or royalties is imposed: Combining tax instruments could give rise to high marginal tax rate as calculated per following formula (Higgins 1992, 59): marginal rate = 100[1-(1-R)(1-P)(1-C)], where R = royalty rate P = add profit tax rate C = corporate rate Formula (for preliminary review of effects) can only apply if all 3 taxes are applied to uniform tax base (ad valorem royalty must be expressed as profit-based consideration. : Risk of high marginal tax rate if combination of taxes or royalties is imposed: Combining tax instruments could give rise to high marginal tax rate as calculated per following formula (Higgins 1992, 59): marginal rate = 100[1-(1-R)(1-P)(1-C)], where R = royalty rate P = add profit tax rate C = corporate rate Formula (for preliminary review of effects) can only apply if all 3 taxes are applied to uniform tax base (ad valorem royalty must be expressed as profit-based consideration.
Cross-country analysis - oil & gas : Cross-country analysis - oil & gas Jurisdictions favour:
Separate oil and gas tax legislation, not part of mining regime
back-end loaded regime due to immediate expensing of all investments
Profile of ‘most favoured’ fiscal regime based on study (1997) comparing 43 countries:
Tax design based on field-by-field approach
95,3% of sample countries levy CIT with average nominal rate of 33,9%
83,7% impose CIT in combination with royalty
12 apply sliding scale royalties based on prod vols: 0-30%
15 impose fixed royalties, from 12 to 15%
14 front-end load through bonus bidding
46,5% impose acreage fees
production sharing contracts are not favoured (only 4)
carried equity participation by Government limited (12%)
rate of return-linked windfall profit taxes are mostly rejected
Competitive outlook for key mining jurisdictions : Competitive outlook for key mining jurisdictions Canadian Fraser Institute Annual Survey of Mining Companies: 2004/05 – based on feedback of 1 121 international senior & junior mining co’s
Policy Potential Index - report card to governments on attractiveness of respective mining policies, tax, environmental regs., admin regs & compliance burden, native land claims/equity participation, infrastructure, labour laws, political stability. Highest possible score on index is 100:
Nevada at 95 (highest), Manitoba 89, Alberta/Ontaria 78, Western Australia 74-78, Chile 74, Chile 74, Mexico 71, Ghana 60, Tanzania 56, China 49, Brazil 47, Peru 46, Zambia 38, Botswana 35, SA 32 (2002/03 still 47), Philippines 24, Russia 19 (4th lowest), DRC 11, Zimbabwe 8 (lowest)
Mineral Potential Index, rates region’s geological attractiveness:
Nevada 96 (highest), Chile 94, Quebec 89, W-Australia 87, Mexico 87, Brazil 83, Mali 80, Tanzania 77, Ghana 76, Peru 74, China 72, Botswana 67, SA 54 (2002/03 71), Russia 53, Zambia 53, Alaska 43, Zimbabwe 22, California 16 (lowest)
Best Practices Mineral Potential Index: shows mineral potential of countries, assuming their policies are based on best practice together with mineral potential:
Tasmania 100 (highest), Alaska 98, W-Australia 97, Russia 93, SA 91 (tied with New South Wales & South Australia, China, Zambia, Mexico), Botswana 84, Ghana & Mali 83, Zimbabwe 60, Ireland 38 (lowest).
Utilisation of royalty revenues : Utilisation of royalty revenues Principal justification: investing royalty take into fund, thereby translating non-renewable resource wealth into permanent wealth
The royalty funds could be allocated either to:
National Revenue Fund as general revenue item for purposes of defraying expenditures on the basis of Government’s spending priorities
Earmarked for future economic growth purposes
Earmarking of these funds on budget only for gross fixed capital formation. Hence, Government never uses these funds for consumption expenditure
Or: Government’s total annual gross fixed capital formation program must at least equal the annual royalty collection?
Gross fixed capital formation in asset classes such as residential & non-residential buildings, public infrastructure, transport equipment, machinery & other equipment
Utilisation of royalty revenues: international practices : Utilisation of royalty revenues: international practices “Are we prepared … to put aside substantial sums of current revenues from the sale of non-replaceable crude oil production, put it aside for our grandchildren and not make it available for current revenue needs, to use it for that day … when some of the wells may have gone dry…?”
Peter Lougheed, premier of Alberta in 1976
Are African states transfering non-renewable mineral wealth into permanent wealth since mining started a century ago?
What are governments’ record of gross fixed capital formation?
Would returns on these infrastructure investments over time equal current mineral sales & mining tax revenues when deposits are depleted?
Preservation of mineral wealth when mines are depleted – is this possible? : Preservation of mineral wealth when mines are depleted – is this possible? Principle: mineral wealth must be invested in something that permanently increases mineral owner’s (=state) command over goods and services.
How have states chosen to use their mineral wealth? What incentives can be used to preserve rather than waste it by consuming income from minerals as soon as they have been extracted?
Hicksian concept of ‘income to mineral extraction’: how much can a country consume out of its current mineral revenues without impoverishing itself in the long run?
International experience - Mineral Rent Investment Funds:
Nauru phosphate deposits – sustainability eroded because of bad decisions
Alaska Permanent Fund – constitutionally enshrined, dividend to all, highly successful, keep management out of hands of spendthrift politicians, preserve state’s mineral wealth for indefinite future, returns distributed among entire Alaskian population
Alberta Heritage Fund – managed by politicians as budget balancing tool, low return investment decision, cross subsidisation of poorer provinces, no dividend program, public awareness very low
Norwegian Petroleum Fund – managed in European parliamentary tradition, independent board of investment managers, Central Bank manages this, annual deposits & withdrawals at discretion of Parliamentary majority, investment portfolio spreads risk, only overseas investments.
Decentralisation of mining taxes vs. revenue sharing : Decentralisation of mining taxes vs. revenue sharing General tax devolution theory deems following taxes as appropriate national/central level tax instruments:
Progressive redistributive taxes
Taxes in support of macroeconomic stabilisation
Taxes on highly mobile production factors / tax bases
Taxes on tax bases distributed highly unequally between jurisdictions
Appropriate state/provincial government taxes:
Taxes on tax bases with low mobility
Residence-based taxes
Taxes on completely immobile production factors
User charges and fees
Fiscal decentralisation principles & tribal / community royalties : Fiscal decentralisation principles & tribal / community royalties Fiscal devolution principles suggest that unequal distribution of mineral deposits should lead to transfer of right to charge royalties to the Centre.
Hence, State could insist on right to collect royalty:
rebate to mineral rights holder could be denied, thus, compelling communities & mineral rights holder to mutually re-negotiate lower royalty rate regime in case additional State royalty would make operation uneconomic?
rebate to mineral rights holder could be allowed but State could impose withholding tax regime on private royalty income received by communities or individuals under the Income Tax system if funds are not appropriated for social expenditure benefiting communities?
State could earmark community grant monies away from communities as a quid pro quo for the right of such communities to receive tax-free mineral royalties?
Community / tribal royalties – a complicated matter still to be resolved in SA : Community / tribal royalties – a complicated matter still to be resolved in SA Mineral rights holders that pay private royalty to certain communities / individuals reject payment of double royalties: in terms of transitional arrangements in MPRDA tribal communities are entitled to continue receiving such payments
POSSIBLE options for avoiding double royalties payment:
Mine may receive offsetting rebate (credit) to the extent of royalty owed to National State
Assume mineral rights holder pays private royalty of 10% to a tribe versus 4% royalty owed to State on same mineral extracted. Under these circumstances, rebate is limited to only 4 per cent
Government could substitute royalty to tribe with equivalent transfer payment from National Revenue Fund, because resource developments impose heavy social, infrastructure, economic & environmental burden on lower levels of government
Revenue-sharing options as in PNG, Indonesia, etc.
‘Resource Curse’ – transparency & accountability regarding mineral taxes : ‘Resource Curse’ – transparency & accountability regarding mineral taxes Resource-based economic & political developments in jurisdiction do not depend on level of resource endowment but―
Sound macro-economic & fiscal policies
Sound public policy & resource management
Disciplined re-investment of resource-based wealth/tax resources (William Ascher 2005, 569)
Policymakers must create rules-based & transparent arrangement for―
Fiscal arrangement for state resource enterprises (must pay royalties)
Oversight & reporting of Auditor-General to Parliament
Protection from political interference
Insulation/independence of monetary institutions
Effectiveness of stabilisation funds
Political rules of democracy that punish leaders abusing resource endowment
Active participation by NGO sector (Global Witness and Conflict Diamonds)
Involvement of Multilateral Organisations transferring best practices on reporting & sound fisca policies