Tax Aspects of Domestic Resource MobilisationDialogue on Enduring and Emerging Issues

Taxation of Natural Resources

Tax Aspects of Domestic Resource MobilisationDialogue on Enduring and Emerging Issues

Taxation of Natural Resources

Characteristics of natural resource exploitation its impact on tax policy design

1. Potential for huge rents2. Volatility of commodity prices structural change surprises3. Enclave status of mines4. Potential for overinvestment into supporting infrastructure5. Politically motivated downstream beneficiation of minerals domestically

extracted vs. creating functional markets6. Ad hoc changes to fiscal regime if windfall profits arise7. Creating power base for elite, thereby encouraging corruption8. What preventive measures exist in expectation of deposit depletion?9. Lack of transparency & accountability regarding tax proceeds10. Tendency to prescribe price controls for domestically produced mineral

resources (ie, oil & gas)11. Trend to introduce state enterprises vs. leaving it to the market12. Environmental degradation:

These factors combined, can trigger the Resource Curse

1. Potential for huge rents2. Volatility of commodity prices structural change surprises3. Enclave status of mines4. Potential for overinvestment into supporting infrastructure5. Politically motivated downstream beneficiation of minerals domestically

extracted vs. creating functional markets6. Ad hoc changes to fiscal regime if windfall profits arise7. Creating power base for elite, thereby encouraging corruption8. What preventive measures exist in expectation of deposit depletion?9. Lack of transparency & accountability regarding tax proceeds10. Tendency to prescribe price controls for domestically produced mineral

resources (ie, oil & gas)11. Trend to introduce state enterprises vs. leaving it to the market12. Environmental degradation:

These factors combined, can trigger the Resource Curse

Historic trends of resource taxation Mining/oil sector dominates economy in many LDCs Resource sector dominated by transnational / foreign cos For centuries royalties formed backbone of mineral taxation Since 1950s combination of fiscal instruments:

Royalties/production taxes (average rates of 2-5%) & ordinary profit taxes Since 2000 global convergence of CIT rates (average of 26.7%)

Since 1970s increasing fiscal burden on mineral sector (oil & gas) More direct government involvement with rising shares in economic rents:

More sophisticated rent sharing measures: resource rent taxes, APT Production-sharing contracts Equity participation (= contract-stability enhancing outcome as automatically

shares in windfall profits)

Race to the bottom: aggressive tax incentives/tax holidays for mining toattract FDI (many African states)

Key policy question: Are tax incentives needed? regional tax coord.

Mining/oil sector dominates economy in many LDCs Resource sector dominated by transnational / foreign cos For centuries royalties formed backbone of mineral taxation Since 1950s combination of fiscal instruments:

Royalties/production taxes (average rates of 2-5%) & ordinary profit taxes Since 2000 global convergence of CIT rates (average of 26.7%)

Since 1970s increasing fiscal burden on mineral sector (oil & gas) More direct government involvement with rising shares in economic rents:

More sophisticated rent sharing measures: resource rent taxes, APT Production-sharing contracts Equity participation (= contract-stability enhancing outcome as automatically

shares in windfall profits)

Race to the bottom: aggressive tax incentives/tax holidays for mining toattract FDI (many African states)

Key policy question: Are tax incentives needed? regional tax coord.

Negotiating fiscal regime fluctuating balance between governments & investors

INVESTORS prefer back-end loading of tax

payments: Low burden fiscal measures

to compensate for project &sovereign risk

Recoup initial capital outlayon mining, oil & gas projectsover shortest time possible

Maximising long-run post-taxreturns

Fiscal stability provisions nowindfall profit taxes whencommodity prices increase

Preference for Rent ResourceTax or Brown Tax (negativetax or subsidy bygovernments)

GOVERNMENTS preferfront-end loading of taxpayments: Securing substantial share of

resource rent Minimising tax-induced

inefficiencies Receive fiscal revenues as

production commences Integrating mining and oil &

gas tax issues into general taxcodes

Simplify tax administration &protect with anti-avoidancemeasures against transferpricing practices

Minimise informationasymmetry as to projectsprofitability

INVESTORS prefer back-end loading of tax

payments: Low burden fiscal measures

to compensate for project &sovereign risk

Recoup initial capital outlayon mining, oil & gas projectsover shortest time possible

Maximising long-run post-taxreturns

Fiscal stability provisions nowindfall profit taxes whencommodity prices increase

Preference for Rent ResourceTax or Brown Tax (negativetax or subsidy bygovernments)

GOVERNMENTS preferfront-end loading of taxpayments: Securing substantial share of

resource rent Minimising tax-induced

inefficiencies Receive fiscal revenues as

production commences Integrating mining and oil &

gas tax issues into general taxcodes

Simplify tax administration &protect with anti-avoidancemeasures against transferpricing practices

Minimise informationasymmetry as to projectsprofitability

Factors determining resource taxationThomas Baunsgaard Primer on Mineral Taxation, IMF WP/01/139

Hard-rock mining: Artisan mining, may escape standard tax regime: only attracting

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 (between12.5% and 20%)

Size of oil field shows high correlation with profitability Production-sharing contracts are common

Gas: Not as profitable as oil demand market must first be created Expensive pipeline infrastructure, cross-border problems, exceedingly

expensive downstream liquification & transportation High political risks, individually negotiated with flexible fiscal regimes

Hard-rock mining: Artisan mining, may escape standard tax regime: only attracting

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 (between12.5% and 20%)

Size of oil field shows high correlation with profitability Production-sharing contracts are common

Gas: Not as profitable as oil demand market must first be created Expensive pipeline infrastructure, cross-border problems, exceedingly

expensive downstream liquification & transportation High political risks, individually negotiated with flexible fiscal regimes

Why does tax design of natural resource sector deviatefrom other economic activities?

Separate fiscal system for resources sector due to resource rent potential(scarcity of resources, Hotelling rule,1931)

Resource rents are surplus return over & above input costs (capital,labour, other production factors, opportunity costs of sunk capital)

Pure rent represents financial surplus that could be taxed away withoutinfluencing econ. behavior or distorting resource allocation

2 risks are present in developing resource projects: Commercial risk Sovereign risk (constructive expropriation by regulation, taxation decisions)

Govts can reduce both risks by adhering to macroecon. & fiscal stability,providing exploration data, delivering good physical infrastructure

Practically, deposit-by-deposit approach difficult to achieve due toinformation asymmetry regarding deposits profit potential, informed by Differing grades Geographic distance to market Infrastructure availability Cost of development Sovereign risk

Separate fiscal system for resources sector due to resource rent potential(scarcity of resources, Hotelling rule,1931)

Resource rents are surplus return over & above input costs (capital,labour, other production factors, opportunity costs of sunk capital)

Pure rent represents financial surplus that could be taxed away withoutinfluencing econ. behavior or distorting resource allocation

2 risks are present in developing resource projects: Commercial risk Sovereign risk (constructive expropriation by regulation, taxation decisions)

Govts can reduce both risks by adhering to macroecon. & fiscal stability,providing exploration data, delivering good physical infrastructure

Practically, deposit-by-deposit approach difficult to achieve due toinformation asymmetry regarding deposits profit potential, informed by Differing grades Geographic distance to market Infrastructure availability Cost of development Sovereign risk

Types of resource taxes No single best model of different tax combinations

Model incorporating self-adjusting tax increases in times of high commodityprices, will guarantee stability of fiscal contract & increase countrys LT-attraction for FDI

Direct tax instruments / in personam taxes / net revenue: Corporate income tax plus capital gains 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, net profits royalties

Indirect tax instruments / in rem: Ad valorem, specific/production volume royalties Import duties, export duties VAT, sales tax Property or capital taxes, stamp duties

Non-tax instruments: Competitive bonus bidding, auctions (e.g., hydrocarbons) Surface or usage fees Production sharing contracts State equity participation

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

Direct tax instruments / in personam taxes / net revenue: Corporate income tax plus capital gains 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, net profits royalties

Indirect tax instruments / in rem: Ad valorem, specific/production volume royalties Import duties, export duties VAT, sales tax Property or capital taxes, stamp duties

Non-tax instruments: Competitive bonus bidding, auctions (e.g., hydrocarbons) Surface or usage fees Production sharing contracts State equity participation

Corporate tax mining (forestry, fishing) Most jurisdictions apply standard corp. rate Higher CIT rates apply in oil & gas sector (bigger rents) Resource deposit specificity, may lead to individually negotiated corp. tax

dispensation for large-scale projects Some jurisdictions exempt mineral extraction activities from withholding

taxes due to higher tax burden on mining cos Special capital allowances for capital intensive projects (100% expensing) Mining rehabilitation / decommissioning trust funds: deduction for

contributions to fund & tax-free buildup of fund Transfer pricing incidence potentially high requires introduction of

OECD-type anti-transfer pricing rules & ring-fencing provisions: TNCs dominate & with multi-jurisdictional operations

Sale of minerals below market prices to affiliates in low-tax jurisdictions

For example: diamonds notoriously difficult to value see lessons fromSouthern Africa on need for GDV

Not all minerals are traded on metal exchanges (vertically integrated firms)

Most jurisdictions apply standard corp. rate Higher CIT rates apply in oil & gas sector (bigger rents) Resource deposit specificity, may lead to individually negotiated corp. tax

dispensation for large-scale projects Some jurisdictions exempt mineral extraction activities from withholding

taxes due to higher tax burden on mining cos Special capital allowances for capital intensive projects (100% expensing) Mining rehabilitation / decommissioning trust funds: deduction for

contributions to fund & tax-free buildup of fund Transfer pricing incidence potentially high requires introduction of

OECD-type anti-transfer pricing rules & ring-fencing provisions: TNCs dominate & with multi-jurisdictional operations

Sale of minerals below market prices to affiliates in low-tax jurisdictions

For example: diamonds notoriously difficult to value see lessons fromSouthern Africa on need for GDV

Not all minerals are traded on metal exchanges (vertically integrated firms)

Progressive profit tax vs. excise-type windfall profit taxe.g., SA gold mining tax formula

Introduction of progressivity into CIT: Governments automaticallyparticipate in greater share of economic rent as commodity prices rise

Various methods: Ad hoc graduated CIT rate linked to higher unit price of commodity or higher

production volume / sales turnover / profit-to-sales ratio Stepped rate structure (not accurate proxy for varying RoR) Monitoring of higher profit ratios administratively costly Taxpayers have increased incentive to under-report income

SA gold mining tax formula with built-in progressivity, linked to levelof profitability of gold mine marginal mine taxed at 0%:

Only taxable income from 5% profit ratio upwards attracts tax Formula:

y = a-(ab/x), where y = tax rate to be determined (sliding scale: higher profits at higher rates) a = marginal tax rate b = portion of tax-free revenue x = ratio of taxable mining income to total income (including non-mining

income)

Introduction of progressivity into CIT: Governments automaticallyparticipate in greater share of economic rent as commodity prices rise

Various methods: Ad hoc graduated CIT rate linked to higher unit price of commodity or higher

production volume / sales turnover / profit-to-sales ratio Stepped rate structure (not accurate proxy for varying RoR) Monitoring of higher profit ratios administratively costly Taxpayers have increased incentive to under-report income

SA gold mining tax formula with built-in progressivity, linked to levelof profitability of gold mine marginal mine taxed at 0%:

Only taxable income from 5% profit ratio upwards attracts tax Formula:

y = a-(ab/x), where y = tax rate to be determined (sliding scale: higher profits at higher rates) a = marginal tax rate b = portion of tax-free revenue x = ratio of taxable mining income to total income (including non-mining

income)

Resource rent taxes (RRT) Garnaut & Clunies-Ross, 1975, 1983) designing neutral

tax, affecting only economic rent: R-factor (investment-payback ratioratio 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 mark-up on rate of return of some other alternative safe investment Tax calculated by increasing annual cash flow (without deductions for

interest cost & depreciation allowance) by hurdle RoR & continuously carryforward until it turns positive

Few jurisdictions have imposed this regime due to back-loaded nature oftax payment (governments bear all the cash flow risk)

Garnaut & Clunies-Ross, 1975, 1983) designing neutraltax, affecting only economic rent: R-factor (investment-payback ratioratio 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 mark-up on rate of return of some other alternative safe investment Tax calculated by increasing annual cash flow (without deductions for

interest cost & depreciation allowance) by hurdle RoR & continuously carryforward until it turns positive

Few jurisdictions have imposed this regime due to back-loaded nature oftax payment (governments bear all the cash flow risk)

Brown tax,even more neutral

Brown tax imposed at flat rate on annual net cash flow withimmediate expensing of all capital expenditure Negative net cash flow would not be carried forward at real rate of interest as

in RRT, BUT triggers govt. subsidy payment to investor Unrealistic, as developing countries dont have cash flow Brown tax absolute neutral -- transfers all risks to governments Governments potentially face huge fiscal losses (negative tax) Will investors trust government in making good on its subsidy promise? It could trigger wasteful utilisation of capital by investor

Hence, universally rejected by governments

Brown tax imposed at flat rate on annual net cash flow withimmediate expensing of all capital expenditure Negative net cash flow would not be carried forward at real rate of interest as

in RRT, BUT triggers govt. subsidy payment to investor Unrealistic, as developing countries dont have cash flow Brown tax absolute neutral -- transfers all risks to governments Governments potentially face huge fiscal losses (negative tax) Will investors trust government in making good on its subsidy promise? It could trigger wasteful utilisation of capital by investor

Hence, universally rejected by governments

Indirect charges: royalties Royalties oldest form of mineral extraction taxation is it a tax???

Imposed in 3 forms:1. Value of mineral sales (ad valorem)

2. Set charge per production volume (= unit or specific royalty)

3. Profit-based or net smelter royalty

Favoured by governments due to front-end loading of tax payments

Is a consideration for right to extract (similar to capital and labour input costs)

Analogous to lease payment: if lessee is operating unprofitably, lessor will notrent-out property for free

High rate royalties deter investments as it increases economic cut-off grade

Will make development of marginal deposit unprofitable

In case of oil/gas production royalties can be imposed on net of cost basis toaccommodate for production & transportation cost

Admin capacity must exist to monitor closely production volumes

Royalties oldest form of mineral extraction taxation is it a tax???

Imposed in 3 forms:1. Value of mineral sales (ad valorem)

2. Set charge per production volume (= unit or specific royalty)

3. Profit-based or net smelter royalty

Favoured by governments due to front-end loading of tax payments

Is a consideration for right to extract (similar to capital and labour input costs)

Analogous to lease payment: if lessee is operating unprofitably, lessor will notrent-out property for free

High rate royalties deter investments as it increases economic cut-off grade

Will make development of marginal deposit unprofitable

In case of oil/gas production royalties can be imposed on net of cost basis toaccommodate for production & transportation cost

Admin capacity must exist to monitor closely production volumes

Ad valorem royalty vs. profit royalty By far the predominant form of mineral taxation is the ad valorem

royalty which simply takes a percentage share of the gross value ofoutput from specified mining project Head & Krever (eds.): Taxation towards 2000 Australian Tax Research

Foundation, p. 210

Ad valorem royalty is determined by applying royalty rate on gross salesvalue of minerals

Royalty does not accommodate: Differences in production costs of minerals Differences in profit ratios from sale of minerals

Profit-based royalty focuses on after-cost profits from sale of minerals

Profit-based royalty base is narrower hence, much higher rate structure(e.g., Canada, at 18% to 21%)

Royalty payments in terms of ITA principles deductible expense

Ad valorem & specific royalties create least uncertainty for governments

By far the predominant form of mineral taxation is the ad valoremroyalty which simply takes a percentage share of the gross value ofoutput from specified mining project Head & Krever (eds.): Taxation towards 2000 Australian Tax Research

Foundation, p. 210

Ad valorem royalty is determined by applying royalty rate on gross salesvalue of minerals

Royalty does not accommodate: Differences in production costs of minerals Differences in profit ratios from sale of minerals

Profit-based royalty focuses on after-cost profits from sale of minerals

Profit-based royalty base is narrower hence, much higher rate structure(e.g., Canada, at 18% to 21%)

Royalty payments in terms of ITA principles deductible expense

Ad valorem & specific royalties create least uncertainty for governments

Advantages / disadvantages of ad valorem royaltyADVANTAGES: Companies cannot artificially inflate costs Less collection risk for Government Royalty adjusts automatically for commodity price & profit fluctuations Non-negotiable aspects of royalty has fiscally stabilising impact:

Communities benefit of increased public resources as mining commences Over long run should maximise investor certainty

Narrow compliance gap as administration is straight forward & predictable However, fair market value must be ascertainableDISADVANTAGES: Base of royalty is broad high rates may unduly erode investor profits Encourages mining of high-grade ores (picking-the-eye) Need command & control measures against high-grading Regulatory capacity to enforce mining of deposit to "average grade of ore" Complex calculations in case of composite minerals in

concentrate/sulphides rock

ADVANTAGES: Companies cannot artificially inflate costs Less collection risk for Government Royalty adjusts automatically for commodity price & profit fluctuations Non-negotiable aspects of royalty has fiscally stabilising impact:

Communities benefit of increased public resources as mining commences Over long run should maximise investor certainty

Narrow compliance gap as administration is straight forward & predictable However, fair market value must be ascertainableDISADVANTAGES: Base of royalty is broad high rates may unduly erode investor profits Encourages mining of high-grade ores (picking-the-eye) Need command & control measures against high-grading Regulatory capacity to enforce mining of deposit to "average grade of ore" Complex calculations in case of composite minerals in

concentrate/sulphides rock

Advantages & disadvantages of profit royaltyADVANTAGES:

Profit royalty has minimal adverse impact on private investment behaviour: Government & investors are both proportionately at risk

It focuses on mines ability to pay But it is a factor payment not a tax!

Royalty calculation does not require segregation based on mineral type,grade, or level of processing

One rate could be applied to all mineral categories

DISADVANTAGES:

Profit royalties may easily be subject to aggressive tax accounting

Comprehensive anti-avoidance measures needed (as in ITA)

High collection risk for government because royalties vary with profits

ADVANTAGES:

Profit royalty has minimal adverse impact on private investment behaviour: Government & investors are both proportionately at risk

It focuses on mines ability to pay But it is a factor payment not a tax!

Royalty calculation does not require segregation based on mineral type,grade, or level of processing

One rate could be applied to all mineral categories

DISADVANTAGES:

Profit royalties may easily be subject to aggressive tax accounting

Comprehensive anti-avoidance measures needed (as in ITA)

High collection risk for government because royalties vary with profits

Non-tax fees not creditable ito DTAsfront-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 ofmineral deposits as anti-competition strategy by firms)

Competitive bonus bidding (petroleum sector) / discovery orproduction bonuses: In competitive bidding market for oil/gas leases, government could get up-front

appropriate share of economic rent

If too few players bid, high risk of collusion with low rent capture for govt.

Front-end loading may discourage marginal resource development

Needs little admin effort

In cases of uncertain geological potential & high sovereign risk, investors areloath to commit significant funds & bidding amounts may generally be too low

Could destabilise project over long run, as initial low bids for potentially richresource may trigger re-negotiations of fiscal terms

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 ofmineral deposits as anti-competition strategy by firms)

Competitive bonus bidding (petroleum sector) / discovery orproduction bonuses: In competitive bidding market for oil/gas leases, government could get up-front

appropriate share of economic rent

If too few players bid, high risk of collusion with low rent capture for govt.

Front-end loading may discourage marginal resource development

Needs little admin effort

In cases of uncertain geological potential & high sovereign risk, investors areloath to commit significant funds & bidding amounts may generally be too low

Could destabilise project over long run, as initial low bids for potentially richresource may trigger re-negotiations of fiscal terms

Production sharing contracts (PSC) oil & gas Ownership of hydrocarbon resource remains with government

throughout exploitation period Operator 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 minus 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

Ownership of hydrocarbon resource remains with governmentthroughout exploitation period Operator 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 minus allowable production costs Profit oil shared in pre-determined ratio between govt. & investor PSCs can be graduated with rising shares to govt. as production volume, crude

price or returns increase Allowable production cost that can be claimed per acct. period can be capped

& carried forward (period or unlimited) = equivalent to royalty

State equity in resource projects Some governments hold equity in resource projects (see

diamond industry in Namibia, Botswana) Securing higher % of economic rent during commodity booms Stability-enhancing & prevent renegotiation of fiscal terms (windfalls) 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 But: 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 concessionary terms Carried interest govt. pays for it out of converted production shares Tax exchanged for equity (reduced tax liability) Equity in exchange for provided infrastructure Free equity, less transparent as taxes may be offset

Some governments hold equity in resource projects (seediamond industry in Namibia, Botswana) Securing higher % of economic rent during commodity booms Stability-enhancing & prevent renegotiation of fiscal terms (windfalls) 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 But: 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 concessionary terms Carried interest govt. pays for it out of converted production shares Tax exchanged for equity (reduced tax liability) Equity in exchange for provided infrastructure Free equity, less transparent as taxes may be offset

Comparative efficiency impact ofresource taxes

Baunsgaard (2001), Daniel (1995) & Garnaut and Clunies-Ross (1983)

Neutrality Investor risk Government/sovereign risk Implementation

Efficiency Stability Projectrisk

Loss Flexibili-ty

Delay Design Adminis-tration

Taxcredit

Fixed fee -3 -3 -2 +3 -2 +3 -2 +2 -3

Royalties -3 -1 -1 +2 -1 +3 -1 +1 -3

CIT -1 +1 0 0 +1 +2 +1 -1 +3CIT -1 +1 0 0 +1 +2 +1 -1 +3

Prog.Profit tax

+1 +3 +1 0 +2 +1 +2 -2 0

RRT +2 +3 +2 -2 +3 -1 +3 -3 -2

PSCs -1 +1 0 0 +2 +2 +2 -2 -3

Paidequity

+3 -1 +3 -3 +3 -2 +3 +3 0

Carriedinterest

+2 +3 0 +3 +3 -3 +3 +1 -1

Fiscal stability / equilibrium clauses Risks affect both investor & government Investors are risk adverse BUT so are LDCs-governments If 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: Hence, progressive profit taxes RRT in theory & to lesser extent CIT or PSCs

Fiscal preservation clauses initially attractive, but over LT expensive as itlimits govt. ability to change fiscal terms in times of super profits

Different forms of stability clauses: Freezing rates & tax base definition Administrative complex if per project Guaranteeing investor share of economic rent 1997: wide-spread fiscal preservation in petroleum sector (out of 109

agreements, 63% provided fiscal stabilisation for all taxes, 14% partial stab.,23% had none)

Risks affect both investor & government Investors are risk adverse BUT so are LDCs-governments If 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: Hence, progressive profit taxes RRT in theory & to lesser extent CIT or PSCs

Fiscal preservation clauses initially attractive, but over LT expensive as itlimits govt. ability to change fiscal terms in times of super profits

Different forms of stability clauses: Freezing rates & tax base definition Administrative complex if per project Guaranteeing investor share of economic rent 1997: wide-spread fiscal preservation in petroleum sector (out of 109

agreements, 63% provided fiscal stabilisation for all taxes, 14% partial stab.,23% had none)

Risk of high marginal tax rate if combination of taxes orroyalties at relatively high rates is imposed:Combining tax instruments, leads to high marginal tax rate as calculated perfollowing formula (Higgins 1992, 59):

marginal rate = 100[1-(1-R)(1-P)(1-C)], whereR = royalty rateP = add profit tax rateC = corporate rate

Formula can only apply if all 3 taxes are applied to uniform tax base (ad valoremroyalty must be expressed as profit-based consideration)

Risk of high marginal tax rate if combination of taxes orroyalties at relatively high rates is imposed:Combining tax instruments, leads to high marginal tax rate as calculated perfollowing formula (Higgins 1992, 59):

marginal rate = 100[1-(1-R)(1-P)(1-C)], whereR = royalty rateP = add profit tax rateC = corporate rate

Formula can only apply if all 3 taxes are applied to uniform tax base (ad valoremroyalty must be expressed as profit-based consideration)

Marginal rate Corporateincome tax

Additional / superprofit tax

Profit-basedroyalty

65.7% 35% 40% 12%

34.9% 29% 0 8.25%

29.1% 25% 0 5.5%

Preservation of mineral wealth when mines are depleted Hicksian concept of income to mineral extraction: how much of countrys

current mineral revenues can be consumed without LT impoverishment? Mineral wealth should be invested, thereby permanently increasing mineral

states command over goods and services Investment in permanent resource rent fund, without depleting principal:

Income earned on Funds assets could substitute tax payments from finiteresource sector when deposits become depleted

International experience - Mineral Rent Investment Funds: 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 returninvestment decision, cross subsidisation of poorer provinces, no dividend program

Norwegian Petroleum Fund managed in European parliamentary tradition,independent board of investment managers, Central Bank-managed, annual deposits &

withdrawals at discretion of Parliamentary majority, investment portfolio spreads risk

Hicksian concept of income to mineral extraction: how much of countryscurrent mineral revenues can be consumed without LT impoverishment?

Mineral wealth should be invested, thereby permanently increasing mineralstates command over goods and services

Investment in permanent resource rent fund, without depleting principal: Income earned on Funds assets could substitute tax payments from finite

resource sector when deposits become depleted

International experience - Mineral Rent Investment Funds: 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 returninvestment decision, cross subsidisation of poorer provinces, no dividend program

Norwegian Petroleum Fund managed in European parliamentary tradition,independent board of investment managers, Central Bank-managed, annual deposits &

withdrawals at discretion of Parliamentary majority, investment portfolio spreads risk

Fiscal decentralisation & tribal / community royalties Fiscal devolution principles: unequal distribution of mineral deposits

should transfer taxing & royalty sharing rights to the Centre Hence, State could insist on right to collect royalty:

In case where tribal communities impose traditionally royalties on resourceextraction, central government may deny rebate to miner, thus, compellingcommunities & mining co to mutually re-negotiate lower royalty rate regime incase additional State royalty would make operation uneconomic?

Rebate could be allowed with State imposing withholding tax regime on royaltyincome received by communities, if funds are not appropriated for socialexpenditure benefiting communities?

Central government earmarks budget allocations away from communities as aquid pro quo for the right of such communities to receive royalties

Most advisable: Revenue-sharing of royalty income to communities -Government substitutes tribal royalty with equivalent transfer payment fromnational revenue fund, since mining activities impose heavy social,infrastructure& environmental burden on lower levels of government

See revenue-sharing options in PNG, Indonesia

Fiscal devolution principles: unequal distribution of mineral depositsshould transfer taxing & royalty sharing rights to the Centre

Hence, State could insist on right to collect royalty: In case where tribal communities impose traditionally royalties on resource

extraction, central government may deny rebate to miner, thus, compellingcommunities & mining co to mutually re-negotiate lower royalty rate regime incase additional State royalty would make operation uneconomic?

Rebate could be allowed with State imposing withholding tax regime on royaltyincome received by communities, if funds are not appropriated for socialexpenditure benefiting communities?

Central government earmarks budget allocations away from communities as aquid pro quo for the right of such communities to receive royalties

Most advisable: Revenue-sharing of royalty income to communities -Government substitutes tribal royalty with equivalent transfer payment fromnational revenue fund, since mining activities impose heavy social,infrastructure& environmental burden on lower levels of government

See revenue-sharing options in PNG, Indonesia

Resource Curse adopt EITI Resource-based economic & political developments in jurisdiction

do not depend on level of resource endowment but Sound macro-economic & fiscal policies, good resource management Disciplined re-investment of resource-based wealth/tax resources

Globally, create binding rules-based & transparent arrangement for Fiscal arrangement for state resource enterprises 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)

Multilateral Organisations insisting on adherence to Extractive IndustriesTransparency Initiative: best practices on reporting & sound fiscalpolicies

PUBLISH WHAT YOU PAY globally binding & condition for ODA?

Resource-based economic & political developments in jurisdictiondo not depend on level of resource endowment but Sound macro-economic & fiscal policies, good resource management Disciplined re-investment of resource-based wealth/tax resources

Globally, create binding rules-based & transparent arrangement for Fiscal arrangement for state resource enterprises 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)

Multilateral Organisations insisting on adherence to Extractive IndustriesTransparency Initiative: best practices on reporting & sound fiscalpolicies

PUBLISH WHAT YOU PAY globally binding & condition for ODA?

Renewable resource taxationR Boadway & F Flatters, 1993. The Taxation of Natural Resources, World Bank WPS

Key characteristics of renewable resources: Renewables generate continuous output / revenue stream if

expeditiously managed They include:

Fisheries Natural forests as opposed to plantations Hydro-electricity Water supplies Clean air Agricultural land

As certain share of resource is exploited, it can replenish itself naturallyor artificially through add. conservation measures

Rate of replenishment depends on stock of resource, natural renewalrate, conservation & husbandry practices adopted by exploiters, ie:

Replanting of forests Regulating size of fish caught Fertilisation practices Use of water reservoir

Key characteristics of renewable resources: Renewables generate continuous output / revenue stream if

expeditiously managed They include:

Fisheries Natural forests as opposed to plantations Hydro-electricity Water supplies Clean air Agricultural land

As certain share of resource is exploited, it can replenish itself naturallyor artificially through add. conservation measures

Rate of replenishment depends on stock of resource, natural renewalrate, conservation & husbandry practices adopted by exploiters, ie:

Replanting of forests Regulating size of fish caught Fertilisation practices Use of water reservoir

Specifically targeted tax measures for renewables Adopted tax measures should not incentivise overexploitation Tax treatment must consider dynamics of resource renewal process:

Some resources (hydroelectricity, fisheries) if managed carefully representcontinuous flow of output (normal profit tax rules & combinations with royalties,severance tax, stumpage fee)

Forestry: there may be cycles of extraction / replenishment which willnecessitate income tax averaging rules to ameliorate high marginal rates

High stumpage fees may lead to environmental degradation

Fishing: who collects royalties from ocean fishing beyond 200 miles zone?

Taxes of standard tax system apply to this sector: Corporate tax & capital gains tax, based on residence basis & creditable ito DTAs

VAT, general sales tax

Special production-based fees, taxes based on source principle: Stumpage fees (specific or ad valorem), not creditable taxes ito DTAs

Special investment incentives for longer loss carry forwards, probably ring-fenced

Adopted tax measures should not incentivise overexploitation Tax treatment must consider dynamics of resource renewal process:

Some resources (hydroelectricity, fisheries) if managed carefully representcontinuous flow of output (normal profit tax rules & combinations with royalties,severance tax, stumpage fee)

Forestry: there may be cycles of extraction / replenishment which willnecessitate income tax averaging rules to ameliorate high marginal rates

High stumpage fees may lead to environmental degradation

Fishing: who collects royalties from ocean fishing beyond 200 miles zone?

Taxes of standard tax system apply to this sector: Corporate tax & capital gains tax, based on residence basis & creditable ito DTAs

VAT, general sales tax

Special production-based fees, taxes based on source principle: Stumpage fees (specific or ad valorem), not creditable taxes ito DTAs

Special investment incentives for longer loss carry forwards, probably ring-fenced

Policy challenges for the future

Is the world moving towards LT super commodity cycle? Is balance of power shifting towards resource-rich countries? Will short-term policy objectives ie, tax revenues lead to renegotiation of

fiscal contracts: windfall profit taxes? Will existing BITs deem this as constructive expropriation? Will this impact adversely on FDI into developing countries? Will windfall profit tax advance as 3rd element of resource taxation? Resource race: extraction offshore beyond 200 nautical mile commercial

zone (oil resources in Artic & Ant-artic sea beds) Planting flags on bottom of Artic Sea OR enhanced Role of the UN:

UN Law of the Sea Treaty Revenue source for UN as world governing body vs. extension of national

commercial boundaries? Obtain revenues from the commons (= offshore minerals, ocean fishing) &

share with land-locked, poor countries (UN will thereby lessen dependency onODA commitments)?

Is the world moving towards LT super commodity cycle? Is balance of power shifting towards resource-rich countries? Will short-term policy objectives ie, tax revenues lead to renegotiation of

fiscal contracts: windfall profit taxes? Will existing BITs deem this as constructive expropriation? Will this impact adversely on FDI into developing countries? Will windfall profit tax advance as 3rd element of resource taxation? Resource race: extraction offshore beyond 200 nautical mile commercial

zone (oil resources in Artic & Ant-artic sea beds) Planting flags on bottom of Artic Sea OR enhanced Role of the UN:

UN Law of the Sea Treaty Revenue source for UN as world governing body vs. extension of national

commercial boundaries? Obtain revenues from the commons (= offshore minerals, ocean fishing) &

share with land-locked, poor countries (UN will thereby lessen dependency onODA commitments)?

Thank you