Taxation and Revenue Sharing Philip Daniel Fiscal Affairs Department International Monetary Fund Establishing Good Governance Plenary Session World Mines Ministries Forum, Toronto March 1, 2008 • The views in this presentation are those of the author and should not be attributed to the International Monetary Fund, its Executive Board, or its management.
Purpose and outline • Consider preconditions for investment in minerals • Outline a general approach to mineral taxation practice • Consider issues and trends in mineral taxation • Outline some country comparisons • Taxation and transparency • Draw some provisional lessons The presentation assumes a focus on a fiscal regime for private (often foreign) investment
A view from an investor • Is there anything there? • Can we extract it? • Can we ship it out? • Can we get our money back? • Can we make a profit? • Who is going to sue us?
Pre-conditions for private investment • Geology and infrastructure • Secure title to mining rights • Satisfactory and stable fiscal regime • Stability in environmental management • Right to market mine products • Right to assign • Foreign exchange retention • International arbitration • Freedom of commercial operation
Mineral rent – value of the resource • Value of the product of a mineral resource minus all necessary costs of production, including minimum return to capital required to induce investment Taxation of rent is not easy… • Uncertainty about grades, costs and prices means resource rent cannot be accurately assessed in advance • The investor’s required rate of return is difficult to identify • The manner in which tax is imposed may affect investors’ perceptions of risk, and thus the required return • Taxing the whole of resource rent is unlikely to be either feasible or efficient • Stability and instability in fiscal terms
Principles for a mineral tax regime • Fiscal regime for minerals cannot move too far out of line with that of countries with competing deposits (with due regard to specific conditions) • Avoid additions to investor risk, where possible, aiming both at more investment and higher shares of rent • Aim for tax neutrality (tax rent), recognizing need for special mineral tax devices • Consider both tax burden and tax structure • Decide which margin is important, and periodically review • Pursue stability and transparency, likely to be easier in a generally applicable regime, or open bidding round, than case-by-case negotiation.
Tax Burden: Changes in Share of Total Benefits + Tax share of total benefits Progressive Regressive + Project pre-tax rate of return
Design of a fiscal regime Balance two sets of considerations • Minimize additional risk to investor of absolute loss; tax realized rent once known, rather than fallible forecast • Offer prospect of stability of fiscal terms: feasible only if the terms offer government revenue share that is perceived to be fair Implied structure • Measures to facilitate early payback (accelerated depreciation, modest royalty) • Focus on taxation of profit (not inputs or gross output), minimizing divergence of pre- and post-tax rates of return • Include some device providing early revenue to government (if only for political support for fiscal stability) • Ensure that the proportion of the rent eventually taxed is high enough to outweigh temptation for future governments to change terms, subject adequate incentive to investors and compensation for risk.
Individual Tax Instruments ROYALTY • Most common form is proportion of value of minerals extracted • Identical to effect of a once-for-all increase in extraction cost, and thus reduces value of the resource • Royalty rates of 5 to 10 percent are prevalent for oil and diamonds, but around 3 percent for metal minerals CORPORATE INCOME TAX • Imposed nearly everywhere, but CIT is not a particularly efficient instrument • CIT rates have settled in the 25 to 35 percent range TAXES ON INPUTS • Import duties and VAT, and withholding taxes on payments for services, form important parts of the tax base in many countries
Additional taxation Resource rent tax • Taxation of cash flows exceeding a specified rate of return in a life of project calculation • Efficient especially where costs of failed exploration can also be recouped Variable income tax or profit-related royalty • Typically varies the rate of CIT, or royalty, according to the ratio of taxable income (or working costs) to total revenues • Can reduce the dispersion of expected outcomes and therefore investors’ assessment of risk may improve • Applied in Ghana’s variable royalty scheme, as an elective scheme for gold mines in South Africa, and under present mining tax regime in Botswana and Uganda. Price participation arrangements • Typically changes the sharing of proceeds when certain threshold prices for commodities are exceeded; sometimes termed a price-related royalty • A blunt, and distorting, that instrument that does not (usually) take account of grades or costs; may be hedged around with conditions • Exists in the Zambian copper industry (underlies new Mongolian legislation, and voluntary contributions in Peru) Profit Sharing Formula (diamonds in Botswana and Namibia)
Current mineral tax issues • Lack of responsiveness of fiscal systems to changes in commodity price environment (a special problem where tax holidays leave royalty as the only effective instrument) • Legacy of special agreements made post conflict, or in “distress” privatizations • Tendency to ignore legislated regimes when under pressure for a desirable investment • Risk of extension of privileged terms to new areas • Relationship of fiscal stability assurances to the tax system • Reliance on CIT system, and thus exposure to excessive debt interest • Transfer pricing, assessment and audit problems generally • Use of EPZ schemes to locate processing, or even mining • Mining tax regimes appear less efficient than most of the petroleum regimes
Comparisons: simulating a gold project • The following two charts compare fiscal regimes, using a stylized gold project • Total output just under 600,000 ounces, over 8 years; US$60 million capital costs; operating and replacement costs average about $25 million p.a. • Chart 1 plots government share of benefits (at 10% discount rate) as project pretax rate of return rises (“benefits” means revenues less operating and replacement costs – the money generated to repay the providers of capital and pay taxes) • Chart 2 shows the government share of net cash flow (at 10% discount rate) in a single case at prices projected by IMF (WEO), constant in real terms after 2012
Taxation and transparency • Extractive Industries Transparency Initiative (EITI) • Starts from reconciliation of payments and revenues • 20 + implementing governments • Kimberley Process Certification Scheme • Certifies origin of diamonds in legal production • Safeguards position of legitimate producers when diamonds are traded • Supports tax administration for diamond production and trade • IMF Guide on Resource Revenue Transparency • Part of Fiscal ROSC process – a voluntary engagement • Full public presentation of legal basis for taxation or production sharing • Encourages publication of mineral agreements covering fiscal terms • Public accountability of national resource companies
Some lessons? • Mineral tax regimes should respond robustly and flexibly to changes in prices and costs • A variety of instruments may be needed to meet multiple objectives, and also to reduce distortions inherent in some common devices • Mineral rent is the preferable tax base, but not easy to target • The overall impact is more important than any single instrument • Poor macroeconomic management and institutional failings complicate mineral tax regimes, and increase investor risk premia • Neutrality does not require the same tax regime as for other industries • Investor confidence, once lost, may be hard and expensive to recover • Fiscal stability assurances have a place, if necessary, when combined with additional tax devices that assure government of a share in substantial rents • A general regime that is regularly reviewed (new generations) is preferable to single project, negotiated terms – although these may be needed in exceptional circumstances (post conflict, privatization).