Extractive Industries Week Taxing the Minerals Industry in Turbulent Times Moderated by Bryan Land Senior Oil, Gas and Mining Specialist, World Bank Preston Auditorium World Bank Washington DC March 4, 2009
Outline of the Session Presentation: Bryan Land 2:00 2:30 Panel Debate: Four Experts 2:30 3:00 Question & Answer 3:00 3:15 Coffee Break 3:15 3:35 (20 mins) Break out Group Discussions 3:35 4:10 Wrap Up 4:10 4:30
Experts Robert Conrad Associate Professor of Public Policy and Economics, Duke University Chair, World Bank External Advisory Panel on EITI++ Former Director of Duke Center for International Development and Director of US Treasury Tax Advisory Program for Central and Eastern Europe Worked in more than forty countries on tax policy James Otto Independent Natural Resources Attorney and Economist Worked in over fifty countries for governments, the private sector, multi lateral institutions and universities Holds degrees in engineering, mineral economics and law, and has led departments/institutes at the Colorado School of Mines, University of Denver and University of Dundee Richard Schodde Managing Director, MinEx Consulting Pty Ltd.; independent consultant providing strategic and economic advice to the mining and exploration industries Worked as a Minerals Economist for the last 30 years, assessing mining and exploration projects in over forty countries for WMC Resources and BHP Billiton Richard provides a company based perspective on the impact of changes in business risk and fiscal regimes on project economics John Strongman John Strongman Consultant, World Bank World Bank Mining Advisor prior to retirement in 2007 30 years in Bank s Mining Unit Worked on a broad range of mining policy, legal and regulatory issues including mineral tax policy and administration issues Worked on mining in all regions of the world with strong experience in countries such as Botswana, Indonesia, Papua New Guinea, Poland, Romania and Zambia
Mineral taxation is a heated issue in many mineral rich rich countries and often lies at the heart of resurgent resource nationalism Many host governments feel they have been deprived of a fair share of mining profits The public is often mistrustful of taxes agreed to on its behalf by its leaders and is often denied the chance to verify these arrangements Investors have grown nervous that governments will change tax levels with little or no consultation or notice Newspaper clippings from Mining and Taxation where to from here? (PWC 2006)
There is a need for more sustainable and fair approaches to mineral taxation 1. Mineral tax systems need to respond better to changes in economic circumstances 2. More robust approaches are needed to make mineral tax systems clear and stable 3. Governments need to be better equipped to collect taxes due and curtail tax avoidance
How were profits shared during the boom? Sorting out reality from perception is a significant challenge because of limited transparency and delays in revenue reporting For a global perspective we have drawn on PWC s annual survey of the top 40 international mining companies This is a narrow sample and results have to be treated with great caution US$ billions 350 300 250 200 150 100 50 0 63% Shares of Mining Profits 45% 40% 38% 2002 2003 2004 2005 2006 2007 Costs Company State * PWC report Mine*:As good as its gets?, 2008 37% 37% 70% State Share % 0% PWC Top40 survey of mining company results* State Share = PWC reported income taxes paid + 5% of gross revenue as a proxy for royalty and duties paid Excludes dividend witholding taxes and dividend receipts from state equity
Behaviour of state revenues as earnings rise As profits rise there is a natural shift in the composition of revenue away from levies on revenues (royalty) and on costs (duties & VAT) to taxes on profits In the analysis 70% of revenue in 2002 came from royalty & duties but by 2007 70% of revenue came from taxes on profits With the change in the composition of revenue also comes a decline in the state share of net revenues In the analysis whereas in 2002 the state share of net revenue was 63%, from 2005 2007 it settled around 37% Omission of dividend witholding tax and dividend earnings on state equity means state share is understated by a few percentage points This level is broadly consistent with mining tax analysis by others The analysis implies that for every US$ of incremental profit, the state would get less than 50% Not surprisingly company earnings rose from 2002 to 2007 by 2000% while state revenues rose 705% The rate at which revenues from taxes grows at a time of growing profitability can also be subdued by: Tax holidays that completely shield profits from tax The write off of prior losses and accumulatied undepreciated capital costs (any uplifts would have increased this amount) The write off of exploration and development drilling programs resumed once earnings start to increase Low collection rates by tax administrations that are not equipped to assess taxable profits compared to royalties & duties
Country experiences and reactions A combination of these factors might explain some of the disappointment among governments at the share of profits received during the boom Government mining revenues in fact grew dramatically Ghana: revenue receipts up 300% from 2002 to 2006 (royalty and income tax) Tanzania: revenue receipts up 250% from 2001 to 2005 (royalty and income tax) Peru: revenue receipts up 950% from 2002 to 2006 after introduction of new royalty in 2004 but was outstripped by company earnings growth (as would be predicted) Indonesia: revenue receipts (all taxes) up 359% and company earnings up 398% from 2002 to 2006 Zambia: analyses showed that state obtained <30% of incremental profits under Development Agreements Attempts to increase taxes on existing mines during the boom were difficult and sometimes acrimonious Re negotiation is often protracted, especially if poorly conducted as in DRC and Guinea In some cases the process ended in unilateral government action, as in Zambia in 2008 and Mongolia in 2007 In Peru and Tanzania, companies agreed to voluntary supplementary payments to meet government and public frustrations Moreover, some of the changes made might have been short sighted, having scared away investors and taken effect just as prices and profits were falling Zambia has now withdrawn the windfall tax
Lessons for mineral tax system design The tax system should have flexibility to accommodate a wide range of economic outcomes rather than tailoring regimes to fit each deposit on a case by case basis Theoretically, the best prescription is a single fiscal regime that does not deter commercialization of average deposits but captures windfalls from high potential deposits We recommend to clients a tax system that provides the government with a minimum revenue stream throughout mineral production but generates additional revenues linked to achieved profits The share of profits should be sufficient to reduce temptation for future governments to change terms while preserving returns that compensate the investor adequately for capital employed and associated risks Since mining involves large amounts of immobile investment we have encouraged governments to consider tax systems that defer some tax revenue to facilitate the investor s early payback
Tax structure The implied tax structure is: a modest production royalty combined with profits based taxation using progressive tax instruments sliding scale net profits royalty variable rate income tax rate of return based profits taxes with provision for accelerated write off of pre production costs and eligible exploration expenses Sliding scale net profits royalty Base rate and then rising rate linked to profit margin Levied either on revenues or on defined profit base Deductible for income tax Variable rate income tax Base rate and then rising rate linked to profit margin Levied on taxable income In place of income tax ROR based profits tax Rate linked to after tax rate of return Levied on after tax cash flow In addition to income tax
Tax level The implied tax level in any particular country is one that is broadly consistent with others having a similar level of geologic opportunity and country risk, over a range of profitability scenarios This can be assessed by cross country comparisons which form part of the World Bank s mining sector analytical work Competition to attract investment among host countries helps to establish upper and lower bounds for the main fiscal metrics z x u s q o m k i g e c a 0 10 20 30 40 50 60 70 80 State Take % State take is the most commonly compared; others are effective tax rate, IRR, NPV Tendency for regional benchmarking to take place e.g mineral tax systems of SADC Comparisons should also test different economic scenarios hi, mid, lo prices and costs to distinguish between regressive and progressive tax systems Purely illustrative but based on a variety of studies that model a hypothetical mine under different tax systems
There is a need for more sustainable and fair approaches to mineral taxation 1. Mineral tax systems need to respond better to changes in economic circumstances 2. More robust approaches are needed to make mineral tax systems clear and stable 3. Governments need to be better equipped to collect taxes due and curtail tax avoidance
Standardization Mineral taxation systems are often far from standardized discretionary powers to negotiate tax concessions on a case by case basis often exist opaque/discretionary processes may favor certain interests over lapping and contradictory incentive regimes may exist (e.g. tax free status given to mineral operations in export processing zones) different taxing ministries often don t talk to each other, militating against a holistic approach government capacity to both make good fiscal policy and to implement it typically weak The World Bank has worked with governments to consolidate uniform tax arrangements in legislation, narrow fiscal discretion, increase transparency and eliminate or significantly reduce scope for case by case tax negotiations mining sector work Mali, Papua New Guinea, Indonesia and Laos has followed this approach and addressed these issues the use of progressive taxes, not only results in more responsive tax systems, but should also lend greater predictability and, therefore, stability, to the tax system
Re negotiation Where countries have, for whatever reason, agreed to tax terms that do not respond adequately to changing economic circumstances, adjustments may be necessary In these circumstances, we have underscored the need for governments to sit down with investors and work in a collaborative manner to modify tax terms on the basis of non discrimination, transparency and due process The Bank will support such efforts by providing governments with access to the new rapid response EI Trust Fund facility.
There is a need for more sustainable and fair approaches to mineral taxation 1. Mineral tax systems need to respond better to changes in economic circumstances 2. More robust approaches are needed to make mineral tax systems clear and stable 3. Governments need to be better equipped to collect taxes due and curtail tax avoidance
Tax adminstration challenges Many tax agencies lack the know how, access to information and resources necessary to measure and value mineral production, classify and verify costs and safeguard against transfer pricing on a reliable basis. Audit capabilities are typically limited. These weaknesses are compounded by a lack of cooperation and information sharing between revenue agencies Low levels of accountability may permit these weaknesses to persist Where multiple tax arrangements co exist these problems are aggravated Weak tax administration capacity provides scope for tax avoidance practices to go undetected Unless such tax administration challenges can be addressed, governments may be compelled to opt for mineral tax systems that require limited knowhow and vigilance to impose (output and revenue based levies) or even participate directly in mining operations to obtain a fair share
Strengthening tax administration Ultimately, adequate resourcing and training in all mineral tax assessment and audit functions is essential starting to be supported in many countries through broader based capacity building programs for tax administrations In Ghana, budget support for natural resource governance includes targets for improved mineral tax collection Mining projects in Papua New Guinea and Mongolia, and the proposed MIGEP project in Guinea, all provide specific assistance to dedicated Mining Tax Units In some circumstances, just in time external technical support for highly specialized functions, such as audit, can be justified, especially where there is a high benefit to cost ratio Finally, little is achievable without robust transparency and reporting, to facilitate information sharing and enable agencies and tax payers to be held to account
Final thought The World Bank considers fair, efficient and accountable taxation to be a cornerstone of good mineral sector governance, together with the wise management and effective use of revenues to induce sustainable development and poverty reduction. Its EITI++ approach offers a framework under which the World Bank and its partners can work with mineral rich countries to achieve this outcome.
Panel debate and discussion groups What measures would you recommend to address each of these issues? o Mineral tax systems need to respond better to changes in economic circumstances o More robust approaches are needed to make mineral tax systems clear and stable o Governments need to be better equipped to collect taxes due and curtail tax avoidance
Basic premise the nation owns sub soil resources then logically the state gets the economic rent Commodity boom caused concerns that nations do not get a fair share 2 fundamentals issoues Design progrssivity Abity to adminsier Profita based audits