International taxation and the extractive industries
International Taxation and the Extractive Industries
The taxation of extractive industries exploiting oil, gas or minerals is usually treated as a sovereign, national policy and administration issue. This book offers a uniquely comprehensive overview of the theory and practice involved in designing policies on the international aspects of fiscal regimes for these industries, with a particular focus on developing and emerging economies. International Taxation and the Extractive Industries addresses key topics that are not frequently covered in the literature, such as the geo-political implications of cross-border pipelines and the legal implications of mining contracts and regional financial obligations. The contributors, all of whom are leading researchers with experience of working with governments and companies on these issues, present an authoritative collection of chapters.The volume reviews international tax rules, covering both developments in the G20-OECD (Organisation for Economic Co-operation and Development) project on base erosion and profit shifting and more radical proposals, identifying core challenges in the extractives sector. This book should become a core resource for both scholars and practitioners. It will also appeal to those interested in international tax issues more widely and those who study environmental economics, macroeconomics and development economics.
Philip Daniel is Honorary Professor at the Centre for Energy, Petroleum and Minerals Law and Policy at the University of Dundee, UK, and Senior Fellow, Natural Resource Governance Institute. He served in the Fiscal Affairs Department of the IMF from 2006 to 2015. Michael Keen is Deputy Director of the Fiscal Affairs Department of the International Monetary Fund. Before joining the Fund, he was Professor of Economics at the University of Essex, UK. Artur Świstak is an economist in the Fiscal Affairs Department of the International Monetary Fund, where he works on tax policy issues. Prior to joining the IMF in 2011, he worked for the Polish Ministry of Finance as a chief of tax policy analysis division. Victor Thuronyi is a graduate of Cambridge University and Harvard Law School. He has practiced tax law, served in the U.S. Treasury Department and taught tax law before joining the International Monetary Fund (1991–2014).
Routledge Studies in Development Economics
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124 Trade, Investment and Economic Development in Asia Empirical and policy issues Edited by Debashis Chakraborty and Jaydeep Mukherjee 125 The Financialisation of Power How financiers rule Africa Sarah Bracking 126 Primary Commodities and Economic Development Stephan Pfaffenzeller 127 Structural Transformation and Agrarian Change in India Göran Djurfeldt with Srilata Sircar 128 Development Management Theory and practice Edited by Justice Nyigmah Bawole, Farhad Hossain, Asad K. Ghalib, Christopher J. Rees and Aminu Mamman 129 Structural Transformation and Economic Development Cross regional analysis of industrialization and urbanization Banji Oyelaran-Oyeyinka and Kaushalesh Lal 130 The Theory and Practice of Microcredit Wahiduddin Mahmud and S. R. Osmani 131 The Economics of Child Labour in an Era of Globalization Policy issues Sarbajit Chaudhuri and Jayanta Kumar Dwibedi
132 International Taxation and the Extractive Industries Edited by Philip Daniel, Michael Keen, Artur S´wistak and Victor Thuronyi
International Taxation and the Extractive Industries
Edited by Philip Daniel, Michael Keen, Artur Świstak and Victor Thuronyi
List of figuresvii List of tablesix List of boxesx Contributorsxi Forewordxv 1 Introduction and overview
PHILIP DANIEL, MICHAEL KEEN, ARTUR ŚWISTAK AND VICTOR THURONYI
2 International corporate taxation and the extractive industries: principles, practice, problems
MICHAEL KEEN AND PETER MULLINS
3 An overview of transfer pricing in extractive industries
STEPHEN E. SHAY
4 Transfer pricing – special extractive industry issues
5 International tax and treaty strategy in resource–rich developing countries: experience and approaches
PHILIP DANIEL AND VICTOR THURONYI
6 Extractive investments and tax treaties: issues for investors
7 Taxing gains on transfer of interest
LEE BURNS, HONORÉ LE LEUCH AND EMIL M. SUNLEY
8 Fiscal issues for cross-border natural resource projects JOSEPH C. BELL AND JASMINA B. CHAUVIN
9 International oil and gas pipelines: legal, tax, and tariff issues
HONORÉ LE LEUCH
10 The design of joint development zone treaties and international unitization agreements
11 Fiscal schemes for joint development of petroleum in disputed areas: a primer and an evaluation
PHILIP DANIEL, CHANDARA VEUNG AND ALISTAIR WATSON
12 Taxes, royalties and cross-border resource investments
JACK M. MINTZ
13 Tax competition and coordination in extractive industries
MARIO MANSOUR AND ARTUR ŚWISTAK
1.1 Proportion of natural resource taxes paid by 2 multinational enterprises 1.2 Government receipts from natural resources, averages 2000–2013 2 2.1 Estimating the revenue loss from BEPS 22 2.2 Numbers of BTTs and TIEAs, 1975–2013 26 3.1 Transfer pricing between two countries – example 1 46 3.2 Transfer pricing between two countries – example 2 47 3.3 Low-tax intermediary – example 3 49 3.4 Host country tax minimization – example 4 64 4.1 Exploiting the use of average prices 88 6.1 Typical life cycle of a mine 136 6.2 Typical cash waterfall 145 7.1 Indirect transfer of interest 173 7.2 Multi-tiered indirect transfer of interest 175 7.3 Indirect transfer of interest involving non-corporate intermediary176 8.1 Illustration of a single-country versus cross-border resource project 191 8.2 Summary of key results 203 9.1 Schematic arrangements of cross-border pipeline projects 225 11.1 Malaysia–Thailand JDZ 270 11.2 Malaysia–Thailand project life revenues and AETR from a stylized 900 MMBbl field 273 11.3 Nigeria–São Tomé e Príncipe project life revenues and AETR from a stylized 900 MMBbl field 279 11.4 Project economics: stylized petroleum project examples 282 11.5 Average effective tax rates for EEZs and JDZs 284 11.6 Timor Sea – joint petroleum development area 286 11.7 Fiscal regime for Bayu-Undan 293 11.8 Sunrise fiscal regime 294 11.9 Timor-Leste and JPDA PSCs 296 11.10 Australia and Timor-Leste: fiscal regimes; 900 MMBbl field 297 12.1 Decomposing the effective tax and royalty rate 2012 314
13.1 Composition of tax revenue in Sub-Saharan Africa: resource vs. non-resource; 1980–2010 13.2 CIT rates in Sub-Saharan Africa 13.3 Worldwide mine production and prices of copper, 2000–2012 13.4 Worldwide production and prices of natural gas, 2000–2012 13.5 AETRs for copper mining in selected countries 13.6 AETRs for natural gas production in selected countries
333 339 340 340 341 342
2.1 Tax treatment of foreign sourced dividends received by 15 corporate taxpayers, 2015 3.1 Example 3: EBT and taxes by company 48 5.1 Namibia: double taxation agreements and provisions 120 5.2 Southern Africa: withholding tax on payments for services to subcontractors 122 5.3 Withholding rates and the capital gains article in double taxation agreements with Kenya 124 8.1 Ranges of parameters in determining the access fee 200 8.2 Key assumptions and financial results under three scenarios 203 10.1 Joint development arrangements – sample of models 246 11.1 Cost recovery limits and shares of excess cost recovery and profit petroleum to contractors 271 274 11.2 Royalty rates for Thailand III 11.3 Rates of special remuneratory benefit using Thai Baht 274 11.4 Summary of Nigeria fiscal terms 277 280 11.5 Contractor profit share in STP PSC 11.6 Contractor profit share from PSC 281 11.7Timor-Leste: PSC fiscal terms and sharing between governments289 11.8 The tax regime applying to Timor-Leste’s PSCs 291 11A.1 Petroleum fiscal terms in simulated countries and their joint development areas 301 12.1 METRRs by jurisdiction (in percent), 2012 314 12.2 METRRs by jurisdiction for a Canadian parent 2012321 12.3 Financing cost by type of investors, 2012 322 12A.1 Data appendix: non-tax parameters by country, 2012 330 13.1 Taxes generally applicable to extractive industries 346
2.1 Crediting of resource taxes in the United States 2.2 International tax planning – tools of the trade 2.3 International tax planning by multinational enterprises – evidence 2.4 Treaty shopping 2.5 Indirect transfers of interest 7.1 Examples of structuring direct and indirect transfers of mining or petroleum rights 7.2 Economic effects of taxing gains on transfers of interest 7.3 Possible impact of transfer on host country future tax revenues 9.1 Examples of existing landlocked export pipelines 9.2 Selected cross-border transit pipelines 9.3 Examples of pipeline transit fees 11.1 The Malaysia–Thailand JDZ production sharing contract 11.2 Petroleum exploration and development in treaty areas
17 19 20 27 29 161 164 167 219 221 234 271 295
Joseph C. Bell is Of Counsel at Hogan Lovells in Washington, DC. His current practice is principally devoted to resource management and fiscal issues in developing countries in Africa, Asia and the Middle East and the negotiation and re-negotiation on behalf of governments of long-term concession and investment agreements in the agricultural and mining sectors. He is Chair of the Board of the International Senior Lawyers Project, www.islp.org, cochair of the Advisory Board of the Natural Resource Governance Institute, http://www.resourcegovernance.org and a member of the Council on Foreign Relations. Lee Burns is Honorary Professor, Graduate School of Government, University of Sydney. Lee specialises in international and comparative tax law. Lee has authored many papers and articles on international tax and has advised the Australian Treasury and the Board of Taxation on the reform of Australia’s controlled foreign company and foreign trust regimes. Since 1991, Lee has provided assistance on the design and drafting of tax laws under the technical assistance program of IMF to more than 30 countries. In recent years, Lee’s technical assistance work has focused particularly on the design of tax law regimes for extractive industries. Jack Calder, now retired, had a long career in the UK Inland Revenue, in the course of which he occupied various senior positions, including latterly that of Deputy Director of the Oil Taxation Office. He then worked for a number of years as a consultant for the IMF and other organizations, advising governments in a wide range of developing countries on the administration of their natural resource revenues. He is author of Administering Fiscal Regimes for Extractive Industries: A Handbook. Peter Cameron is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee and Professor of International Energy Law and Policy. He is Co-Director of the International Centre for Energy Arbitration, Professorial Fellow of the Law School at the University of Edinburgh, Fellow of the Chartered Institute of Arbitrators and member of the London Court of International Arbitration. He is the author or editor of more
than a dozen book-length publications, mostly on international investment and energy. He has given oral and written testimony in a number of international arbitrations. Jasmina B. Chauvin is a Research Fellow at the Center for International Development at Harvard University and a doctoral candidate in Strategy at Harvard Business School. Her research seeks to understand the drivers of firm location and firm productivity, with a particular focus on the role of trade and of transportation barriers. Prior to starting her doctoral studies, Jasmina was policy advisor to the government of Liberian President Ellen Johnson Sirleaf. Previously she worked in infrastructure and energy finance at Citigroup and as a freelance consultant to the World Bank, the National Resource Governance Institute and various national governments. Philip Daniel is Honorary Professor at the Centre for Energy, Petroleum and Minerals Law and Policy, University of Dundee, and Senior Fellow, Natural Resource Governance Institute. He Chairs the Advisory Board of the Oxford Centre for the Analysis of Resource Rich Economies in the Department of Economics, University of Oxford. Philip Daniel previously worked for nine years at the Fiscal Affairs Department (FAD) of the IMF, part as Deputy Head,Tax Policy Division and part as Advisor in FAD’s Front Office. He is co-editor of The Taxation of Petroleum and Minerals: Principles, Problems and Practice. Janine Juggins is EVP Global Tax Unilever. Before joining Unilever, she was the Global Head of Tax at Rio Tinto. Janine has more than 25 years of international tax experience gained with companies in the engineering, energy, mining and FMCG sectors working in both the U.S. and the UK. She has a special interest in tax and development issues. She graduated in French with German from Manchester University, UK, and subsequently trained as a Chartered Accountant with KPMG in London. She is also a Chartered Tax Advisor, UK, and Associate Corporate Treasurer, UK. Michael Keen is Deputy Director of the Fiscal Affairs Department of the International Monetary Fund. Before joining the Fund, he was Professor of Economics at the University of Essex and Visiting Professor at Kyoto University. He was awarded the CESifo-IIPF Musgrave Prize in 2010, and is an Honorary President of the International Institute of Public Finance. He has led technical assistance missions to more than 30 countries and is coauthor of books on The Modern VAT, the Taxation of Petroleum and Minerals and Changing Customs. Honoré Le Leuch has more than 40 years’ professional experience in international oil and gas activities and is an acknowledged consultant on petroleum legislation, taxation and contracts, institutional and regulatory regimes, economics and negotiation. He was formerly with IFPEN and its affiliate Beicip-Franlab. H. Le Leuch is an Honorary Lecturer at the Centre for Energy, Petroleum and Mineral Law and Policy (CEPMLP) of the University
of Dundee. He is a co-author of the reference book on International Petroleum Exploration and Exploitation Agreements: Legal, Economic, and Policy Aspects. Mario Mansour is Deputy Chief, Tax Policy Division, IMF Fiscal Affairs Department. Before joining the IMF in 2004, he managed tax policy projects in the Middle East and Eastern Caribbean islands for a consultancy (2000–03), and was a tax policy analyst for the Canadian Federal Department of Finance (1992–2000), where he started his career, specializing in business and international taxation and micro-simulation modeling. Mario has advised on tax policy issues in more than 30 countries. His recent publications cover taxation issues in the Middle East and Africa, tax coordination in West Africa and fiscal stabilization in the oil and gas sector. Jack M. Mintz is the President’s Fellow at the University of Calgary after stepping down as the founding Director of the School of Public Policy, July 1, 2015. He is also the National Policy Advisor for EY as well as serving on several private and public boards. He has served as the Clifford Clark Visiting Economist at the Department of Finance 1996–1997, when he chaired a panel whose report became the basis for business tax reform in Canada. Peter Mullins is a Deputy Division Chief with the Tax Policy Division of the Fiscal Affairs Department of the International Monetary Fund in Washington, DC. Peter has extensive experience in tax policy and tax law, having been involved in the area for more than 25 years. Peter has provided advice to more than 40 countries on a range of tax policy issues including corporate tax, personal tax,VAT, international tax issues, natural resources taxation and property taxes. Prior to joining the IMF in 2005, Peter was the General Manager of the Business Tax Division in the Australian Treasury. He has worked in both the private and public sectors, including many years as a senior official in the Australian Tax Office. Stephen E. Shay is a Senior Lecturer on Law at Harvard Law School. Before joining the Harvard Law School faculty as a Professor of Practice in 2011, Mr. Shay was Deputy Assistant Secretary for International Tax Affairs in the United States Department of the Treasury. Prior to joining the Treasury in 2009, Mr. Shay was a tax partner for 22 years with Ropes & Gray, LLP. Mr. Shay has published scholarly and practice articles relating to international taxation and testified for law reform before Congressional tax-writing committees. He has had extensive practice experience in international taxation, including in transfer pricing counseling and controversies. Mr. Shay is a 1972 graduate of Wesleyan University, and he earned his J.D. and his M.B.A. from Columbia University in 1976. Emil M. Sunley served at the IMF as an Assistant Director in the Fiscal Affairs Department, specializing in tax policy advice to transition countries, postconflict countries and countries with petroleum extraction or mining. Prior to that, he was a tax director at Deloitte and Touche, Deputy Assistant Secretary for Tax Policy at the U.S. Treasury and a senior fellow at the Brookings
Institution. He is a graduate of Amherst College and earned his Ph.D. in economics at the University of Michigan. Artur Świstak is an economist in the Fiscal Affairs Department of the International Monetary Fund, where he works on tax policy issues. He has advised more than 15 countries on their tax reforms, including on natural resources taxation. Prior to joining the IMF in 2011, he worked for the Polish Ministry of Finance as a chief of tax policy analysis division. Mr. Świstak holds M.A. and M.P.S. degrees. Currently he is pursuing his Ph.D. in economics. Victor Thuronyi is a graduate of Cambridge University and Harvard Law School. He has practiced tax law, served in the U.S. Treasury Department and taught tax law before joining the International Monetary Fund in 1991. He has worked on tax reform in numerous countries. He is the author of Comparative Tax Law (2003) and other writings on tax law and policy. He retired in 2014 as lead counsel (taxation), IMF. Chandara Veung was formerly a research assistant in the Tax Policy Division of the Fiscal Affairs Department. He managed databases of fiscal regimes for extractive industries, regularly analyzed them using the FARI modeling framework as part of the IMF’s missions and conducted modeling trainings. He is currently pursuing an MBA at Harvard Business School. Alistair Watson was formerly a technical assistance advisor in the Tax Policy Division of the Fiscal Affairs Department and is now a freelance consultant. He specializes in extractive industry fiscal regime design and analysis and helped develop the modeling framework FAD uses in this work. After FAD, Alistair worked as a commercial director with Baker Hughes, a major oil field services company, and since returning to freelance he works with the IMF, World Bank and a number of consulting firms.
The topic of this book may sound esoteric. It is not. What is at stake are the economic prospects not only of one of the world’s important economic sectors, the extractive industries, but the prospects for many of the world’s poorest people. The reason is simple. Revenues from the extractive industries make a critical contribution to the fiscal position of resource-rich countries, including many lower-income countries struggling to find the means to strengthen their infrastructure and protect their vulnerable; much of those revenues come from multinationals; and multinationals are hard to tax in ways that secure reasonable revenue without discouraging investment. So for many countries a central part of their development agenda involves the international dimension of the tax treatment of multinational enterprises active in the extractive industries. For some, too, the regional and cross-border dimension of projects or policies adds further tax issues. Managing these complex challenges is, for them, key to achieving the robust revenue base and effective institutions needed for sustained growth. These issues lie at the intersection of two broader topics to which the Fund has devoted considerable attention. The first is the design and implementation of fiscal regimes for the extractive industries. In this, the present book complements two earlier Fund publications, Daniel and others (2010) and Calder (2014). The second is the taxation of multinationals more widely. This has been the focus of much attention in recent years, notably with the G20-OECD project on base erosion and profit shifting (BEPS), now entering its implementation phase. The Fund itself has long been active in supporting our members in this area, as described in IMF (2013), including through analytical work (such as IMF, 2014). Despite significant progress, however, considerable challenges clearly remain. In drawing together these two themes, this book draws deeply on the Fund’s extensive technical assistance work with our members. Much of this has been made possible by the generosity of donors contributing to a dedicated trust fund to support our work in the extractive industries – including the preparation of this book. It is a pleasure to thank, for this, the governments of Australia, the European Union, Kuwait, the Netherlands, Norway, Oman and Switzerland.
Addressing the highly technical difficulties raised in the various chapters will require a mix of legal, economic and administrative skills, as well as a detailed understanding of how the extractive industries operate. This book does not provide any simple or single route to success. But it will, I hope, help those seeking to navigate these always difficult, sometimes murky and often stormy waters. Christine Lagarde Managing Director, IMF
References Calder, Jack. (2014), Administering Fiscal Regimes for Extractive Industries: A Handbook (Washington, DC: International Monetary Fund). Daniel, Philp, Michael Keen and Charles McPherson, eds. (2010), The Taxation of Petroleum and Minerals: Principles, Practices and Problems (London, New York: Routledge). International Monetary Fund. (2013), Issues in International Taxation and the Role of the IMF (Washington: International Monetary Fund). Available at http://www.imf.org/external/ np/pp/eng/2013/062813.pdf International Monetary Fund. (2014), Spillovers in International Corporate Taxation. Available at www.imf.org/external/np/pp/eng/2014/050914.pdf
1Introduction and overview Philip Daniel, Michael Keen, Artur Świstak and Victor Thuronyi
Issues and context The mismatch between where natural resources are found and where they, or their derivatives, are needed means that the business of finding, developing and selling them has for centuries been inherently international. The modern manifestation of this is the importance within the sector of large multinational enterprises – and their dominance where the state does not own all assets above the ground, as well as the resources below. Several state-owned enterprises have now themselves become important multinationals in the resource sector. Among resource-rich countries, for instance, multinationals account for the vast bulk of fiscal receipts from private business activity in the sector, especially in petroleum: in Ghana, Liberia, Peru and Trinidad and Tobago, they account for all such receipts (see Figure 1.1). In designing fiscal regimes for the extractive industries, international aspects – including the opportunities for tax planning by multinationals to avoid their liabilities – thus need to be center stage. This book aims to provide a comprehensive (and comprehensible) account of these sometimes difficult issues. The importance for resource-rich countries of managing these difficulties needs little emphasis. Receipts from the extractive sector are a – often – the major source of revenue in many countries (Figure 1.2), especially, though not only, in Africa and the Middle East (where state-owned enterprises have a central and even dominant role). The central task for policy makers is to design fiscal regimes for the extractive industries that raise sufficient revenue, provide adequate incentives to invest and are implementable at reasonable cost to both the government and taxpayers. These challenges receive considerable attention when resource prices and the potential revenue are high. But those are precisely the circumstances in which achieving these objectives is easiest. It is when resource prices seem set for a lengthy subdued spell, as at the time of writing, that the trade-offs can be most brutal, the resilience of regimes most tested, coherence in the design and implementation of taxation in the extractive industries most needed – and the importance of ensuring effective taxation of multinationals is most pronounced.
2 Daniel, Keen, Świstak and Thuronyi 100 90
Percent Paid by MNEs
80 70 60 50 40 30 20 10
Notes: data from EITI; excludes payments made by state-owned companies *: Only includes income taxes
Figure 1.1 Proportion of natural resource taxes paid by multinational enterprises
Mining and Petroleum Revenue
60 50 40 30 20 10 Brunei Iraq Equatorial Guinea Libya Saudi Arabia Oman Kuwait Bahrain Angola Congo Republic Nigeria Timor-Leste Algeria Yemen Iran United Arab Emirates Chad Qatar Azerbaijan Sudan Venezuela Botswana Trinidad and Tobago Myanmar Kazakhstan Syria Cameroon Mexico Ecuador Bolivia Malaysia DRC Indonesia Papua New Guinea Russia Vietnam Guinea Norway Mauritania Mongolia Ivory Coast Chile Zambia Uzbekistan Colombia Peru Namibia Niger Ghana Kyrgyz Republic Sierra Leone Tanzania Australia South Africa Brazil Lesotho United Kingdom Canada Philippines
Figure 1.2 Government receipts from natural resources, averages 2000–2013 (Selected countries, in percentage of total revenue excluding grants.)
The difficulty of taxing multinationals – not only or even especially in the extractives, has attracted considerable concern and attention in recent years. Discontent is apparent not only in public disquiet at the success of aggressive
Introduction and overview 3
tax planning by many multinationals but also in the discourse and actions of many emerging and developing countries that have perceived themselves as being placed at a disadvantage by current arrangements. This discontent has been especially apparent in the extractive industries. Mongolia’s renunciation of its tax treaty with the Netherlands, for instance, was prompted by dissatisfaction at the consequent treatment of a large copper mining project;1 and one of the more controversial responses to the difficulties of transfer pricing – the ‘sixth method’ – is used specifically in relation to natural resources and other broadly homogeneous commodities for which some benchmark market price can be found. Substantial discontent is perhaps not surprising, as the basic structure of the current international framework was set out at the time of the League of Nations, when the extent of transactions within firms and importance of hard-to-value intangibles were much less and political power relations very different. It has led to an ambitious attempt to strengthen that system, in the G20-OECD project on base erosion and profit shifting (BEPS).2 While the implications remain to be seen (and are considered in various chapters of this book), it seems clear that while they may mitigate they will not eliminate many of the challenges that arise – including not least in the extractive industries. What is increasingly clear is that the revenue at stake is substantial and quite possibly greater (relative to GDP) in non-OECD economies: Crivelli, de Mooij and Keen (2016) put it, for them, at around 1 percent of GDP, which, given that tax revenues are commonly in the order of 15 percent of GDP in low-income countries, is a sizable amount. And there is increasing evidence too that the sums at issue can be especially large in the extractive sector. Many of the international tax issues that arise in the extractive industries are, of course, far from unique to the sector. Profit shifting through intra-firm lending, for instance, is a generic difficulty with multinationals. But, as in other areas, common problems often loom especially large by virtue of the sheer scale of their operations and the unusually high nominal tax rates that are commonly applied, since these amplify the gains from shifting profits to lower tax jurisdictions. Moreover, the location of resource deposits often does not respect national boundaries or requires cross-border co-operation for development and export of products. These features present special cases of the wider international fiscal challenges. This book does not address all aspects of international taxation but focuses on two sets of issues: those that have proved especially important, problematic and recurrent in the extractive industries and those that arise from specific aspects of the operations of extractive enterprises, such as those that arise from cross-border infrastructure or joint developments in disputed maritime zones. In focusing on these issues, this book complements both Daniel, Keen and McPherson (2010), which focuses mainly on domestic aspects of fiscal regime design, and Calder (2014), which focuses on administrative issues. As there, the present book mainly takes the perspective of resource-producing
4 Daniel, Keen, Świstak and Thuronyi
emerging-market and developing countries. That is where the international tax challenges for the extractive sector arise in most pronounced form and, within the wider fiscal scheme of things, are most significant for both revenue and wider economic performance. Their significance in Africa, for instance, is highlighted and explored in Africa Progress Panel (2013). These are also the cases in which the IMF, through its technical assistance and other activities, tends to become most closely involved3 with many of the authors of this book playing leading roles. An appendix later in the chapter lists some of the international tax issues that are most frequently encountered in this advisory work and that guided the selection of topics for this book.
This book The book can be thought of as falling into four parts. The first sets the scene for the discussion of international tax issues in the extractive industries. The second part takes up generic issues in international taxation with an eye to the specifics of the application to the extractives, focusing on transfer pricing issues, tax treaty strategies and design and the taxation of capital gains associated with natural resources. Cross-border issues, including those related to international pipelines and joint development zones, are taken up in the third part of the book. The fourth part takes up some core policy issues: the interactions between components of fiscal regimes and inter-governmental tax competition and coordination in the extractive sector. Setting the scene for the chapters that follow, Michael Keen and Peter Mullins provide in Chapter 2 an overview, with an eye to the extractive industries, of the current international tax framework, common tax planning devices and recent initiatives to address them. They also review the emerging evidence pointing to the considerable scale of profit shifting both in general and, perhaps especially, in the extractives and in non-OECD countries. This chapter also highlights three specific issues that later chapters examine in more depth: the difficulties of the arm’s length principle and transfer pricing, treaty abuse and the taxation of capital gains on asset transfers. On the first of these issues, transfer pricing, Stephen Shay provides in Chapter 3 an overview of major rules that apply in the context of extractive industries in resource-rich developing countries. He considers a number of examples and discusses steps that developing countries can take to mitigate transfer pricing tax avoidance by multinationals. Jack Calder complements this analysis in Chapter 4 by focusing on complications added by ring-fencing, special methods for valuing extractive industry sales and special rules for costs. In addition, he considers a number of tax administration issues, particularly special benchmarking and ‘physical audit’ procedures. Chapter 5 by Philip Daniel and Victor Thuronyi outlines the principal international tax and fiscal regime issues faced by developing countries engaged
Introduction and overview 5
in natural resource extraction or exploration. The focus of the chapter rests on corporate tax issues for extractive industries. It considers the principal elements in tax treaty strategy that form an integral part of tax policy making.The chapter concludes with a brief discussion of defensive steps that developing countries can take unilaterally. The role of tax treaties in the extractives sector is further taken up in Chapter 6 by Janine Juggins, who – writing from the investor’s point of view – provides an overview of the different types of taxes that arise over the life cycle of a mine, followed by a discussion of the relevance of tax treaties to investment financing decisions, the role that tax treaties play in relation to capital gains and in supplementing gaps in domestic tax law. Further to that, she considers the importance of tax treaties as a component of foreign investment tax policy development and choices. In Chapter 7 Lee Burns, Honoré Le Leuch and Emil M. Sunley focus on the tax treatment of gains arising on a transfer of a mining or petroleum right under both domestic tax law and tax treaties – which has proved a controversial issue in many countries. They investigate the complexities concerning the characterization, valuation, timing and geographic sourcing of the gain both made directly by the holder of the right or indirectly by a person disposing of an interest in the entity holding the right. Joseph C. Bell and Jasmina B. Chauvin in Chapter 8 set the scene for discussion of cross-border projects. They focus on potential arrangements for allocating the taxable income from a project crossing national boundaries among different national entities, using as an example a hypothetical mining project with the mine and infrastructure in two different countries. In Chapter 9 Honoré Le Leuch focuses specifically on the key role of crossborder pipelines in the global oil and gas industry and their commercial structure and taxation. He highlights the striking differences and challenges between the two main categories of transnational pipelines and provides a brief review of the international law applicable to landlocked countries and transit countries.The chapter also highlights the special issues pertinent to the design of the tax regime applicable by each state to the segment of a transnational pipeline under its jurisdiction, as well as possible interactions between the regime and international taxation and double tax treaties. Joint development zones are discussed in Chapter 10 by Peter Cameron and Chapter 11 by Philip Daniel, Chandara Veung and Alistair Watson. Chapter 10 discusses design of joint development zones (JDZs) treaties and international unitization agreements. This outlines the conceptual framework for both arrangements and the differences between them, focusing largely on legal aspects and international obligations. It compares JDZ and unitization structures, providing examples of actual operations and challenges therein. Chapter 11 then examines the fiscal structure of JDZs and sets out examples from around the world, drawing lessons for the future use of this important institutional structure.
6 Daniel, Keen, Świstak and Thuronyi
Interactions between different tax regimes and instruments are the topic of Chapter 12, by Jack M. Mintz. He shows how to assess the impact of oil tax and royalty regimes on investment decisions by calculating an effective tax and royalty rate for marginal projects. The analysis highlights several cross-border fiscal issues that affect the incentive to invest and the resource revenues derived by governments. This chapter also looks at the impact of various financial strategies of multinational companies when investing abroad such as transfer pricing, conduit financing and the discount rate for carrying forward unused deductions under rent-based royalties. The book concludes with an analysis by Mario Mansour and Artur Świstak of the issues of tax competition and coordination in the extractive industries. In Chapter 13 they attempt to answer the key questions of whether tax competition is a reality in relation to the extractives and if so, why (which is far less obvious than it may seem), which taxes it affects – and, critically, to what extent and in what ways governments should consider coordinating their tax treatment of the extractive industries.
Appendix International tax issues in some IMF FAD advisory work on resource-rich countries
Coverage This appendix draws upon advisory work between 2010 and 2014 in about 20 countries and upon regional workshops. Advice or analysis specific to individual countries remains confidential.
Scope The international or BEPS issues arising included: source and residence taxation, double tax treaties (including border withholding taxes), transfer pricing, thin capitalization limitations, taxation of gains on transfers of interest in immoveable property and mineral rights and the treatment of financial instruments. Recent activity reflected an upsurge of interest from the authorities in the content and desirability of double taxation treaties and in the taxation of gains on transfers of interest.
Source and residence taxation A few countries inherited territorial systems at independence that had already been substantially amended in the jurisdictions formerly governing. In some cases, technical assistance (TA) recommended an explicit switch to worldwide taxation of resident individuals and corporations. In other cases, recommendations to widen the definition of permanent establishment (especially for provision of services) and to strengthen or clarify definitions of domestic source income were made.
Introduction and overview 7
Double tax treaties TA consistently recommended that governments refrain from concluding new tax treaties, at least until a uniform and consistent national policy on treaties has been formulated.The policy should ensure full taxing rights with respect to extractive industries, border withholding on dividend, interest and royalty payments abroad and also payments for services.Where the existing treaty network was limited, the recommendation sometimes included maintenance of full legislated rates of border withholding. As an alternative to treaties, TA sometimes recommended tax information exchange agreements (TIEAs) or joining the Convention on Mutual Administrative Assistance in Tax Matters. Full integration of treaty policy with domestic tax policy was advised, making the point that many things done in treaties could be done in domestic law in a non-discriminatory way. One example concerns introduction of a rule that a cost is not deductible unless the counterpart receipt is also taxable and perhaps taxable at some minimum rate. Some of the TA reports gave a detailed analysis of existing treaties and the treaty-shopping opportunities the treaty network might present. More recent TA has recommended introduction of a provision in domestic legislation that would protect against treaty-shopping practices. The same suggestion (together with a possible ‘principal purpose’ rule) came from the BEPS reports: should a multilateral treaty instrument eventually become effective, the appropriate national action might, of course, change. TA has not called for repudiation of ratified treaties, but recommendations were made to clarify the validity or operation of very old treaties. In some cases, treaties that were signed but not ratified had serious inadequacies, and the authorities were advised to review them before ratification. In one case (Mongolia) the authorities independently decided to seek treaty renegotiations.
Transfer pricing The detail of treatment of transfer pricing policy issues deepened in more recent advice.The standard position has called for adherence to the arm’s length principle and implementation, by various means, of the OECD guidelines on transfer pricing. In many cases, the introduction of advance pricing arrangements (APAs) was proposed. In more recent cases, TA suggested stronger powers for the authorities to make regulations on transfer pricing. Some TA called for consistent transfer pricing rules for transactions among residents as well as with non-residents. Some TA (especially where oil and gas is involved) has suggested use for tax purposes of transfer pricing rules devised for transactions among private parties (such as the ‘transfer at cost’ rules among affiliates for services under joint operating agreements) or devised for production-sharing contracts.
8 Daniel, Keen, Świstak and Thuronyi
For the pricing of extractive industry outputs, reference prices (sometimes with adjustments) have been put forward where these are available.
Thin capitalization limitations The recommendation has usually been to strengthen overall limitations on the deductibility of interest rather than to propose something specific for extractive industries. In some cases, however, it was necessary to recommend removal of provisions in production sharing contracts that permitted recovery of interest as a cost. TA has offered both a debt-equity ratio test and a test of the ratio of interest expense to income in different circumstances. In a few cases, both were suggested in combination. In one case legal advice called for reclassification of finance leases as loans and also for use of rules analogous to those for thin capitalization for other types of base-eroding payments. TA usually advised against using a distinction between interest payments nominally between third parties and those between affiliates. Taxation of gains on transfers of interest in immoveable property and mineral rights
Recent TA has recommended that such gains be taxed as income within the corporate tax system rather than through a separate capital gains tax or segregated stream of capital transactions within the corporate income tax. The recommendation to tax follows political preference rather than a specific economic analysis or consideration of alternatives. In earlier TA, the point was made that (as, for example, in Norway) transactions within the petroleum tax ring-fence could be considered post-tax – in the sense that no tax would be due on any gain and no deduction available for any outlay – provided that the overall taxation of resource rents was appropriate. Recommendations have differed on whether to follow the course of segregating capital transactions (the U.S. model) so that payment of premiums for acquisition can only be offset against future capital transactions of a similar nature or to follow the more widespread treatment of the cost of acquisition of mineral rights under which the cost is amortized (usually over the life of the right). Both courses have justification, and the choice between has depended on local circumstances. In either case, a frequent issue has been whether to define mineral rights as immovable property (or to make transactions in them taxable in their own right as assets) and then to ensure that both domestic law and treaties permit the taxation of transactions in such property by non-residents. TA has adopted more than one approach to the problem of taxing indirect transfers of interest through disposal of shares in companies holding mineral rights or non-resident companies holding such companies. Recommendations