Title: World Bank Institute in cooperation with the Poverty Reduction
1World 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
2Contents
- 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
3Natural 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)
4Characteristics 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
5Specific 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
6Historic 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?
7FDI 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 - Africas 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 - SAs FDI flows stagnant in US terms since 1994
- Once-off flows in 2005 only source of increase
8FDI - Role of tax policy
- Its 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 Banks 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
9Enhancing 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
10Negotiating fiscal regime fluctuating balance
between governments investors
- 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
- 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) -
11Is 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)?
12Recent economic pressures on profit tax rates
13Recent economic pressures on profit tax rates
14Recent economic pressures on profit tax rates
15Recent economic pressures on profit tax rates
16Recent economic pressures on profit tax rates
17Recent economic pressures on profit tax rates
18Recent economic pressures on profit tax rates
19General principles in resource taxationThomas
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
20General 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 Mozambiques Pande Namibian
Kudu gas fields
21 and remember that tax is not neutral
Karl Marx
Alan Greenspan
- Theres only one way to kill capitalism by
taxes, taxes, and more taxes.
- All taxes are a drag on economic growth. Its
only a question of degree.
22Why 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 governments perfect
information on deposits profitability
23Mining 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.
24Types 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 countrys
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
25Corporate 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
26Putting 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
27Corporate 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
28Progressive 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) -
29SA 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.
30Tax effect of gold mining formula Y 45-225/X
31Average tax rate on total income, once taxable
income exceeds 5 tax tunnel ? Y 45-225/X
32Resource 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
investors 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
33Resource rent taxes - continued
- Cash flow in large projects is initially negative
(US1-2 billion initial investment) - By increasing each acct. periods cash flow with
hurdle RoR (real interest rate), real value of
cash flow is maintained (investors 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
34Brown 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
35Indirect 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
36In 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 countrys 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
37Ad 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
38Advantages 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
39Disadvantages 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
40Advantages of profit royalty
- Profit royalty has minimal adverse impact on
private investment behaviour because Government
investors are both proportionately at risk - It focuses on mines 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
41Disadvantages of profit royalties
- Profit royalties may easily be subject to arms
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
42Risks 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
43Royalty 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)
44Australia - 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
45Western 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 A450 per ounce, rate of royalty payable is
1.25 of royalty value of gold metal produced
46Western Australia royalty rates as on 1 January
2003
47Western Australia royalty rates as on 1 January
2003, in Australian /c
48Cross-country analysis of royalty regimes
49Cross-country analysis of royalty regimes
African jurisdictions
50SA proposed royalty rates (2003)
51International royalty rate (in ) comparisons
across commodities
52International royalty rate (in ) comparisons
across commodities
53International royalty rate (in ) comparisons
across commodities
54International royalty rate (in ) comparisons
across commodities
55Total Tax vs. Total Sales, in Rand
56Other 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
57Non-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
58Production 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
59State 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 governments 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
60What 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 investors
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
61Economic 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
62Comparative efficiency impact of resource taxes
?Baunsgaard (2001), Daniel (1995) Garnaut and
Clunies-Ross (1983)
63Fiscal stability clauses
- Risks affect both investor government
- Investors are risk adverse BUT so are govts 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
642004/05 Cross-country tax rate analysis
PriceWaterhouseCoopers Corporate Taxes
Worldwide Summaries April 2005 NBER Working
Paper on Developing Countries Tax Structures
652004/05 Cross-country tax rate analysis
PriceWaterhouseCoopers Corporate Taxes
Worldwide Summaries April 2005 NBER Working
Paper on Developing Countries Tax
Structures2006 Index of Economic Freedom
Heritage Foundation Wall Street
JournalDeloitte.Touche Guide to Key Fiscal
Information, Southern Africa, 2005/06
662004/05 Cross-country tax rate analysis
PriceWaterhouseCoopers Corporate Taxes
Worldwide Summaries April 2005 NBER Working
Paper on Developing Countries Tax
Structures2006 Index of Economic Freedom
Heritage Foundation Wall Street
JournalDeloitte.Touche Guide to Key Fiscal
Information, Southern Africa, 2005/06
67Risk of high marginal tax rate if combination of
taxes or royalties is imposedCombining tax
instruments could give rise to high marginal tax
rate as calculated per following formula (Higgins
1992, 59) marginal rate 1001-(1-R)(1-P)(1-C)
, whereR royalty rateP add profit tax
rateC corporate rateFormula (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.
68Cross-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
69Competitive 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 cos - 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 regions
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).
70Utilisation 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 Governments 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 Governments 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
71Utilisation 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?
72Preservation of mineral wealth when mines are
depleted is this possible?
- Principle mineral wealth must be invested in
something that permanently increases mineral
owners (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 states 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.
73Decentralisation 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
74Fiscal 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?
75Community / 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.
76Resource 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