Why are tax revenues from mining so low in many countries
... and what can be done about it?
April 2012
Frian Aarsnes
Principal Consultant
2
The basis for taxation:
revenue generator AND market regulator
• Taxes raise revenue to finance common goods and services
• Taxes are however also used to correct economic
imperfections (market failure)
- information asymmetries - companies use information to reduce taxes
tax system needs to correct asymmetries by promoting disclosures
- non-competitive markets – the market is not liquid enough
tax system needs to ensure correct benchmarks
- principal-agent problems – the agent (company) pursues his own
interest and not the principal’s (country)
tax system needs to give incentives to cost saving, not tax saving
- externalities – prices do not reflect the full cost or benefits of producing
a product
 tax system needs to ensure environmental costs are taken care of
3
TAX BALANCE:
Tax levy in front-end loaded vs back-end loaded tax systems
High
Ability to collect taxes
Windfall
taxes
Ring-fence
CT with
accellerated
depr
Special
taxes on
profits
CT with
100 %
capital
allowance
Medium
CT with
slow depr
Participation
PSC with
not cost oil
No ring-fence
PSC with
low cost oil
Low
Royalties
Signature
bonuses
Front-end
loaded tax
systems
© Pöyry
Neutral tax
systems
Back-end
loaded tax
systems
Type of tax system
Primary concern of MNE's can be summed up in the following items:
1.
Minimum uncertainty = Maximum stability of factors influencing the investment, including the fiscal system
2.
Shortest possible payback-time for the invested amount including profits
3.
Least costly way of repatriating investment and profits
Why are taxes so low … and what can be done about it - No. 1
WHY ARE TAXES SO LOW
• Tax systems are made back-end loaded (fast tax depreciation, no
ringfence) without increasing the tax rate
–
Norway has a back-end loaded tax system … with a 78% tax rate,
hence the success of the Norwegian petroleum tax system
WHAT CAN BE DONE ABOUT IT
• Ringfence mines and don’t allow a fast tax depreciation if tax rates
are low (royalty + corporate taxes)
OR
• Keep fast tax depreciation and no ringfence, but introduce tax
mechanisms that allow higher tax rates (resource taxes, windfall
taxes in addition to royalty & corporate taxes)
TAX MECHANISMS:
Need to cover all the major cost/price situations
LOW COST
Quadrant
2
Quadrant
3
HIGH
PRICE
LOW
PRICE
Quadrant
1
The Quadrant
Cross © Pöyry
Quadrant
4
HIGH COST
A STABLE tax system
needs to have tax
mechanisms that
covers all quadrants
and have the tax
mechanisms being
calibrated correctly
against eachother.
Any tax system that
fails to cover all 4
quadrants will from
time to time
experience instability
in their tax regime
TAX MECHANISMS:
A classification
LOW COST
Corporate
taxes, gross
taxes deductible
Q2
General,
Net profit
based
Q3
Resources,
Net profit
based
HIGH
PRICE
LOW
PRICE
Royalties, fees,
Loss carry forwards
The Quadrant
Cross © Pöyry
Resource
taxes,
gross taxes deductible,
CT variably deductible
Q1
General,
Gross
revenue
based
Q4
Resources,
Gross
revenue
based
HIGH COST
Windfall taxes,
Variable rate royalty,
No deductions,
No loss carry forward
The main tax mechanisms
LOW COST
Royalties
Corporate
taxes
Resource
taxes
Royalties
Loss carry
forward
Windfall
tax
LOW
PRICE
Calibration of resource rent
taxes and windfall taxes are
difficult by themselves
because
– A resource tax cannot be
set so high that it truly
HIGH
captures high prices
PRICE
– A windfall tax threshold
cannot be set so low it
HIGH COST
Windfall taxes are a
SAFETY VALVE, not a
main revenue generator!!
endangers high cost mines
Combining tax elements that
cover Quadrant 3 and 4 gives
however the ideal mechanism
to get both calibrations right
Why are taxes so low … and what can be done about it - No. 2
LOW COST
Experience:
Corporate
taxes are
lowered
Royalties
Corporate
taxes
Resource
taxes
Experience:
Resource
taxes are
low or nonexistant
HIGH
PRICE
LOW
PRICE
Royalties
Loss
carry
forward
Windfall
taxes
HIGH COST
The Quadrant Cross © Pöyry
Experience:
Windfall
taxes as a
safety
valve, are
almost nonexistant
The normal situation should have been
… but often are
Royalty
Corporate
taxes
Resource
taxes
World high cost mine =
Marginal production
Windfall
taxes
Why are taxes so low … and what can be done about it - No. 2
WHY ARE TAXES SO LOW
• In the initial stages of mining industry development
–
corporate tax rates are lowered
– stabilization clauses are given
– too little thinking has gone into fiscal design to cover all the 4
quadrants  taxes are foregone
WHAT CAN BE DONE ABOUT IT
• DO NOT lower corporate tax rates
• DO NOT give general stabilization clauses
• Design into the tax system resource taxes (quadrant 3), but give (if
necessary) tax holidays of a few years for the first companies
• Design into the tax system windfall taxes (quadrant 4), but set the
threshold so high that these taxes acts as a safety valve towards ultrahigh prices, ie do not expect revenues from windfall taxes under normal circumstances.
Why are tax revenues from mining so low in many countries …
• No 1: Back-end loaded tax systems without increased tax rates/ringfence
• No 2: Not all the necessary (or the wrong) tax mechanisms are in place
In addition
• No 3: Information asymmetries in the
– negotiation phase
– tax return phase
• No 4: Derivatives are used for moving revenues out of countries
• No 5: Tax administrations lack penalty mechanisms
• No 6: Tax administrations are too lenient towards the companies, hence
tax audits are late, shallow and are not being followed-up
• No 7: Tax administrations are not supported enough by the ministries,
and ministries are therefore negotiating away taxes that should
have been paid
… and what can be done about it?
• No 1: Fiscal design
• No 2: Fiscal design
In addition
• No 3: Information asymmetries needs to be adressed by
– negotiation phase: having Ministry of Finance & resource ministries
talk together, have experts to feasibility study checking
– tax return phase: have proper disclosure mechanisms in place
• No 4: Have derivatives split out in a tax base separate from mining
• No 5: Introduce penalty mechanisms in the legislation and use fairly
• No 6: Tax administrations should use external experts for the most
complicated issues (IT systems, derivative abuse etc)
• No 7: Taxes should NEVER be negotiated, neither by ministries or courts
(a court ruling should decide taxability, not the tax amount)
Conclusion
Faulty fiscal design and entry
negotiations are by far the
largest mechanism whereby
mining countries loose revenues.
40 %
35 %
30 %
25 %
Non-ringfence is mostly a timing
issue and is thus not a major
mechanism
20 %
15 %
10 %
Mispricing of products and
derivatives abuse are actually
larger than cost transfer abuses.
5%
0%
This is a graphical representation of
where loss of tax revenue originate based
on our experience with many different
countries (not one single country)
A MAJORITY OF TAX LOSSES
IS WITHIN THE INDIVIDUAL
COUNTRY TO DO SOMETHING
ABOUT
Conclusion
• Heavily influenced by the mining country government institutions
– Fiscal design process before a new industry type is introduced
(use experts to avoid unstable tax regime)
– Thorough feasibility study checking before entering into a
development agreement (use experts before and during
negotiations)
– Introducing proper ringfence and proper disclosure and penalty
mechanisms
– Introduce price benchmarking and remove derivatives from the
mining tax base (derivatives should be in a separate tax base)
• Little influence by the mining country government institutions
– Cost transfer pricing abuse – adequacy of the tax administration
– Other (other criminal behaviour by the company) – adequacy of
police and criminal investigation units
Conclusion – choices to me made
LESS RISK, LOWER &
EARLIER REVENUE
Ring fence
Slower tax depreciation
No consolidation
No resource taxes
Small or no tax shield
Windfall taxes
High windfall threshold
No deductibility for
gross taxes in net taxes
BALANCE?
Ring fence?
Faster tax depreciation?
Consolidation?
Resource taxes?
High tax shield?
Windfall tax?
High windfall threshold?
Deductibility?
MORE RISK, HIGHER &
LATER REVENUE
No ring fence
Faster tax depreciation
Consolidation
Resource taxes
High tax shield
No windfall taxes
Low windfall threshold
Deductibility of gross
taxes in net taxes
Conclusion
It all boils down to
LEGAL SYSTEM
CHOICES OF MECHANISMS
CALIBRATION OF MECHANISMS