Resource Taxation: Matching Design with Administration

Lusaka Norad Workshop 18 and 19th April, 2012

Charles McPherson and Alistair WatsonWith input from Jack Calder

Key Design Objectives

• Efficiency (neutrality)– Economic pre-tax / economic post-tax

• Progressivity– Government take positively correlated with profitability

• Early , dependable revenues

Key Administrative Objectives

• Simplicity– Minimize number of fiscal instruments / parameters

• Easily monitored– Readily observable / verifiable indicators

Conflicting Objectives?

• Efficient or neutral tax design often perceived as conflicting with administrative objectives

• Administrative simplicity can be at odds with design objectives…

• Challenge: finding a workable balance

Pro

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Achieving Efficiency Using Profits Taxation (1)

Mine productionQ*

Tax on profit

Profit after tax

Marginal cost per unit of output

Tax

F

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Inventory of mines

Achieving Efficiency Using Profits Taxation (2)

Not viable

Viable

Long term expected price

Profit after tax

Mine C unit cost

DE

Mine Aunit Costs

Mine B unit costs

x*

Production

Mar

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rod

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ion

co

sts/

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Price

Achieving Simplicity (at the cost of efficiency): The Case of Royalties (1)

Royalty increases cut-off grade; decreases production

Q*

Marginal cost per unit of output

Q2

R

F

Pro

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vera

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un

it c

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s/p

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Inventory of mines

Achieving Simplicity (at the cost of efficiency): The Case of Royalties (2)

Not viable

Viable

Long term expected price

Mine CD

E

Mine AMine B

R

x*y

Progressivity and Regressivity

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Government take (%)+

Pre-take profitability +

Progressive

Regressive

Achieving Progressivity In Practice

Link fiscal mechanism(s) to:• An easily observable proxy for profitability; or• Profitability itself (ROR)

Problems With Proxies (1)Government "take" responsive to:

Government "take" linked to ProductionPrice

changeCosts

Timing ofcash flows

Cost ofcapital

Production (daily or cumulative)

Yes No No Partly No

Price (price caps or base prices)

No Yes No No No

Revenue (price and production)

Yes Yes No Partly No

Cost recovery(uplifts and write-off rates)

No No Yes Partly Partly

Simple indicators (location, vintage, and so forth)

Partly Partly Partly No No

Variable Income tax Ratio of taxable income to revenue

Yes Yes Yes No No

Rate of return (ROR) Yes Yes Yes Yes Yes

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Problems With Proxies (2)

• They are proxies…• Partial, inaccurate, measurement of profitability• Likely to quickly become outdated• Simplicity proves an illusion. Instead:

– Complexity– Require revisions– Enhanced perceptions of risk– Pressures for stability clauses

Nigeria PIB: Problems With Proxies (3)

• Royalties are a function of:– Price– Production rate– Type of hydrocarbons– Location (water depth)

• Production sharing is a function of:– Production – Location

• Tax regime varies with – Location– Type of hydrocarbons– Field size

Resource Rent Tax (1)

• Targets rents/profits – efficient• Adjusts automatically to actually achieved

profitability - highly progressive

Resource Rent tax (2)

• Administratively simple? observable indicators?– Simple data requirements (same as income tax)– Simple calculation

• Capacity issues?– Build/engage expertise rather than settle for weak fiscal

design

Recommended Approach

No “perfect” regime, but …• Modest, fixed royalty (3-5%)• Corporate income tax (30%)

– With resource specific rules• Additional rent capture mechanism based on

profitability measure• Investment in administrative capacity

Coffee Break Topics

• Transfer pricing• Thin capitalization• Ring fencing• Fiscalization point (for royalty; CIT; RRT)• Infrastructure charges• Stabilization• Hedging• Fraud

Thank you

BACKUP SLIDES

Keeping it simple

Royalties Fixed ratesLimit differentiation between minerals (~3 categories)Base = FOB port of export (or gross value?)Use benchmark prices for valuationDisallow hedging

Corporate Income tax (CIT)

Simple straight-line depreciation rules- two or three categories of capital only

Segregate (or disallow) hedgingLimit debt (thin capitalization)Separate ring fencing by project [or contract area]

Rent capture Captures increased share of actual realized profitUses same data as required for CIT•Resource Rent Tax•Variable income tax

Complications That Can Be Avoided

• Having too many mechanisms• Case by case negotiation of fiscal regimes• Use of “Frozen law” stabilization• Fragmenting administration across multiple

institutions– Tax authority; Sectoral ministry; National oil company

• Complicated government equity arrangements

Complications That are Hard to Avoid

• Physical measurement of production– Volume/weight and assays– Requires equipment and technical expertise

• Valuation of production• VAT treatment (refunds versus exemptions)• Taxing non-residents (withholding tax)• Taxation of gains on transfers of interests (indirect

transfers)• Granting stabilization of terms

RRT Example

• 20% RRT where pre-tax rate of return exceeds 15%• All data is from CIT return

– NCF = Taxable income + interest + depreciation – capital additions

• Brought forward ANCP balance contains all past information• Simple calculation

Year 1 2 3 4 5 6

Gross Revenues (from CIT return) - 100 200 300 300 300

Costs excluding interest (from CIT return) 100 150 150 100 100 100

Net cash flow (100) (50) 50 200 200 200

Accumulated net cash position (ANCP) b/fwd: - (100) (165) (140) - -

15% Uplift added to negative balance - (15) (25) (21) - -

Closing balance ANCP (100) (165) (140) 39 200 200

RRT @ 20% - - - 8 40 40

RRT Issues

• Ring fence– Ideally, by project– In any case, same as CIT

• Taxing point: – Either; FOB port, or– Mine gate – not inside the mine– Align with royalty valuation

• Infrastructure/transport charges– If provided by separate legal entity, arm’s length charges– Push rent upstream - low “Utility” rate of return for

infrastructure