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Title: World Bank Institute in cooperation with the Poverty Reduction


1
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

2
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

3
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)

4
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

5
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

6
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?

7
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
  • 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

8
FDI - 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

9
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

10
Negotiating 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)

11
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)?

12
Recent economic pressures on profit tax rates
13
Recent economic pressures on profit tax rates
14
Recent economic pressures on profit tax rates
15
Recent economic pressures on profit tax rates
16
Recent economic pressures on profit tax rates
17
Recent economic pressures on profit tax rates
18
Recent economic pressures on profit tax rates
19
General 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

20
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 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.

22
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 governments perfect
    information on deposits profitability

23
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.

24
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 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

25
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

26
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

27
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

28
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)

29
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.

30
Tax effect of gold mining formula Y 45-225/X
31
Average tax rate on total income, once taxable
income exceeds 5 tax tunnel ? Y 45-225/X
32
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
    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

33
Resource 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

34
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

35
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

36
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 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

37
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

38
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

39
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

40
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 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

41
Disadvantages 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

42
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

43
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)

44
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

45
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 A450 per ounce, rate of royalty payable is
    1.25 of royalty value of gold metal produced

46
Western Australia royalty rates as on 1 January
2003
47
Western Australia royalty rates as on 1 January
2003, in Australian /c
48
Cross-country analysis of royalty regimes
49
Cross-country analysis of royalty regimes
African jurisdictions
50
SA proposed royalty rates (2003)
51
International royalty rate (in ) comparisons
across commodities
52
International royalty rate (in ) comparisons
across commodities
53
International royalty rate (in ) comparisons
across commodities
54
International royalty rate (in ) comparisons
across commodities
55
Total Tax vs. Total Sales, in Rand
56
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

57
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

58
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

59
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 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

60
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 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

61
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

62
Comparative efficiency impact of resource taxes
?Baunsgaard (2001), Daniel (1995) Garnaut and
Clunies-Ross (1983)
63
Fiscal 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

64
2004/05 Cross-country tax rate analysis
PriceWaterhouseCoopers Corporate Taxes
Worldwide Summaries April 2005 NBER Working
Paper on Developing Countries Tax Structures
65
2004/05 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
66
2004/05 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
67
Risk 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.
68
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

69
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 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).

70
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 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

71
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?

72
Preservation 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.

73
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

74
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?

75
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.

76
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
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