Tax in the Extractives: World Bank Group Perspective
Rich Stern
Lead Tax Officer World Bank Group
Mexico City, Mexico 4 July, 2014
Revenues from Natural resources
Source: IMF Fiscal Affairs Department
FDI in mining is not correlated to tax rates
ARG
AUS
AUTBELBRA
CAN
CHNCRI
CZE DNKECU
FIN FRADEUGRC
HKG IND
IDN
IRL ITA JPNKOR
MYS
MEX
NLD
NGANOR
PER
PHLPOL RUS
ZAFESP
SWECHETHAGBR
VEN
01
23
4
US m
inin
g FD
I as
a %
of G
DP
0 10 20 30 40METR 2012
US mining FDI outflow to country X as a % of country X's GDP Fitted values
Introduction: WBG has been working in the extractives in a piecemeal way for years
♦ Bank’s Oil, Gas, and Mining Unit (SEGOM) develops/ supports government policy frameworks-also home to EITI
♦ WBI has been instrumental in transparency issues—especially contracting as well as knowledge sharing and data collection
♦ IFC Oil, Gas, and Mining Department –taking direct and indirect investment positions in extractives investments
♦ IFC Advisory Services has provided TA on facilitating linkages, public private partnerships, and leveraging FDI spillovers
♦ Global Business Taxation Team has provided TA targeted at reforming and implementing tax regimes conducive to investment while protecting the revenue base
The international agenda has generated a rethinking of a coherent extractives initiative, launched Oct. 2013
• G8 and G20 focus on both domestic resource mobilization and tax transparency has led to focus on extractives (St. Petersburg Summit, 2013)
• EITI focus on setting standards for reporting and transparency
• Base erosion and profit shifting action plan identifies harmful tax competition and tax avoidance , transfer pricing, investment financing
• as key issues • WBG internal focus on transparency in contracting,
responsible investment, and pivotal role of tax as key component
Knitting together various pieces of WBG work into a global initiative
Extractives Industry
DVLP
Direct and indirect
investment (IFC)
Transparency in contracts
Extractives Policy TA,
development and linkages Transparency
and EITI Initiative
Business Taxation Technical
Assistance
Drilling down on what we do in tax in the extractives: Individual workstreams
♦ Tax incentives (all), instruments, provision, administration, and monitoring ♦ VAT instrument and administration (relates incentives, refunds as well as local content and sourcing) ♦ Transfer pricing and international taxation issues, relating both to
related-party transactions directly related to the investment as well as use of investment as a profit shifting platform.
♦ Working through public-private dialogue groups to gain consensus for reforms
What instruments do we have at hand?
Revenue rise due to increased investment
Social benefits from increased investment
Indirect cost of incentives
Lost revenue from investments that would have been made anyway
> + +
Benefits
9
Social Benefits include cleaner environment,
better skills, better health, etc.
Costs
1. Incentives: costs and benefits
AUS
AUT
BEL
BWA
BGR
CANCHL
DNK
FJI
FINFRA
GEO
DEU
HKG HUN
ISL
IRL
JAM
JPNKOR
LVA
MYSMUS
MEX
NLD
NZLNOR
PER
PRT
ROM
SGP
SVK
ZAFESP
SWE
CHE
THATUR
GBR
USA ARGBGDBOL
BRA
TCD
CHN
CRI
HRV
CZE
ECU ETH
GHA
GRCINDIDN
IRNITA
KAZJOR
KEN
LSO
MDG
MARNGA PAKPOL
RUSRWA
SRBSLE
VNM
TUNUGA
UKREGY
TZA
UZB
ZMB
010
2030
FDI a
s %
of G
DP
-20 0 20 40 60METR
High IC countries Low IC CountriesTrend High IC countries Trend Low IC Countries
Fiscal Policy Effectiveness and the Investment Climate
Almost no impact of lowering Effective Tax Rates on FDI in low IC countries
10 Source: James and Van Parys, 2009
Incentives: what and where
Most incentives are granted to offset or mitigate high, fixed start up costs
♦ Most typical tax CIT-based (holidays, deferments, reductions) designed to mitigate exploration cost, but timing is off use possibly as a vehicle in related party transactions
♦ VAT/import duty exemptions are common, especially but not exclusively in mining Used in combination with import duty exemptions, but can have
impact on local content/domestic sourcing Sometimes ringfenced, so VAT application depends on the
transaction(hard to monitor, promotes misclassification) and refund issue comes into play
♦ Other typical tax incentives: capital allowances and deductions, accelerated depreciation
Once you’ve given away the store, is there any good practice left?
♦ TRANSPARENCY IN ALL INCENTIVES—both in terms of what they are, how they are applied, and who gets them.
♦ Limit CIT holidays. As a second best option, don’t extend tax holidays to investments in extractive-related services.
♦ To this end, think about applying transfer pricing and other international tax principles to the indirect investments.
2. VAT: affects direct investment and spillovers
Issues ♦ VAT is a barrier to investors (policy
breaks in the chain, VAT refunds issues, compliance issues)
♦ VAT efficiency and administration ♦ Link VAT to MSME where needed
(can be in MSME work) ♦ Perception of VAT as gross, not net
(interest free loans to government) ♦ VAT refund request trigger audits ♦ VAT refunds delayed if processed at
all ♦ Cash flow (gov. and private sector)
Solutions ♦ Analysis of VAT value chain-
diagnostic on breaks in the chain
♦ Diagnostic on refund process ♦ Collect good practice policy
and admin systems ♦ Develop sector specific
knowledge applied to VAT ♦ Develop km RBA component
for ex-post refund audit ♦ Develop simple estimator for
refunds levels ♦ Develop menu of integrated
solutions with treasury function
2. VAT Selection of good practice lessons learned so far
♦ Countries which employ risk-based approach to VAT administration and especially VAT refund adjudication have higher and faster rates of refunds, and higher net revenues (Baltics, South Africa)
♦ Relatedly these countries which use “risk channeling” (green channel, red channel) are the most effective
♦ VAT refund timing and level is an indicator for how effective VAT system is (Europe, LAC)
♦ Most advanced VAT refund techniques do not involve cash in-cash out, they involve either virtual accounts or accounting techniques (Lithuania)
♦ Countries with VAT refund forecasting tools have the most effective VAT refund systems (Baltics, Europe)
♦ Dedicated “VAT Refunds” account at the Central Bank, populated with a share of previous month VAT revenue
Traditional taxonomy of approaches + offset options
Source: Harrison and Krilove (IMF) 2007
Selected newer approaches for VAT refunds (from country practice study)
♦ Cash and Virtual accounts booked at time of import and export, with time determined by economic activity (Bulgaria)
♦ Non-cash payment at import, compliance accounting exercise as a part of monthly reporting form, yearly reckoning (Lithuania)
♦ Refunds credited to past and future (expected) tax liabilities—any national level tax (being considered by Albania), requires more IT sophistication.
TRANSFER PRICING
Important part of DOMESTIC RESOURCE
MOBILIZATION
TP for developing countries in G20’s
PLAN
Increase in FDI flows, trade and the
importance of MNEs CIVIL SOCIETY advocating for more
transfer pricing awareness/
enforcement for developing countries
Multinational investors are seeking more CERTAINTY IN THE INVESTMENT
CLIMATE
3. Transfer pricing
♦ Public sector priorities: Protect the income tax base
Provide attractive investment
climate
Neutral treatment of domestic
and multinational businesses
Competition among Tax
Authorities to secure a “fair”
share of MNE’s taxable profit –
double taxation
♦ Private sector priorities: Minimize global tax, starting
with source country tax
Tax risk => shareholder
pressure
Adjustments, Double taxation,
penalties (and interest)
Managing compliance costs
(legislation is growing across
jurisdictions)
Reputational risks
18
Transfer pricing in developing countries
What is the global trend in transfer pricing:
Specific transfer pricing legislation is being introduced Arm’s length principle – comparability and OECD methods
Some deviations observed:
Deviation from market price concept (10/20% etc)
Transactional profit methods not specified
Extension of law to transactions with “tax havens”
New disclosure requirements
Targeted capacity building within tax administrations
APA programs are being considered / developed
Formalization of the competent authority function (MAP)
SAFE HARBORS!
♦ Capital flight and illicit flows ♦ Inter-relationship with customs valuation ♦ Tool to suppress wage claims (to demonstrate subsidiary
is not profitable) ♦ Joint ventures - Artificially decreasing profits to reduce
amount of JV profits to be shared ♦ Circumvent foreign exchange controls ♦ Inter-relationship with royalty tax
Importance of TP goes beyond the transaction
Summary: Technical assistance offerings—what we do
Workstream ♦ Tax Administration
Simplification
♦ Sub-national Taxes & Regulations
♦ Small Business Tax Reform
♦ Tax Legal & Appeals Reform
♦ Risk-based Audit System
♦ Tax Incentives Reform
♦ International Taxation
Issues addressed Business tax administration is
burdensome (CIT, VAT) Misuse of regulatory fees as
revenue tools (esp. sub-national)
Small business facing high compliance costs
Overly complex, cluttered tax laws & appeals system
Excessive and discretionary tax audits
Tax competition has led to sub-optimal tax incentive structure
Distinguishing between tax
evasion and tax avoidance
Tools
METR Analysis
Tax Admin Process Mapping
Standard Cost Model (SCM)
Compliance Costs Surveys
Inventory of Fees & Charges
Incentives Review
Profit Margin Analysis
TP Needs Assessment
Yemen
The Business Tax Program
Central African Republic
Burkina Faso Guinea Bissau
Guinea Benin
Cameroon
Central Asia Region - Kyrgyz Republic, Tajikistan, Uzbekistan
Pakistan India, Bangladesh Nepal
Lao PDR Vietnam Thailand
SEE Region –Albania, Bosnia & Herzegovina, Serbia
East African Community - Burundi, Kenya, Rwanda, Tanzania, Uganda
Liberia Sierra Leone Cote d’Ivoire
Ghana Indonesia
Papua New Guinea Solomon Islands
Ethiopia
Armenia Georgia
Azerbaijan
Honduras Costa Rica El Salvador
Colombia
Peru
Panama
Caribbean Region (OECS)