Home >Government & Nonprofit >Taxing the extractive sector

Taxing the extractive sector

Date post:15-Apr-2017
Category:
View:221 times
Download:0 times
Share this document with a friend
Transcript:
  • ICTD Extractive Industries Workshop 7 th December 2014

    Frian Aarsnes State Authorized Public Accountant Director

    7. December 2014

  • ICTD Extractive Industries Workshop 7th December 2014

    Frian Aarsnes State Authorized Public Accountant Director

    7. December 2014

    OIL&GAS

    MINING

    RESEARCH

    INFRASTRUCTURE

    POWER*

    ECONOMICS

    STRATEGY

  • 3

    Taxing the Extractive Sector

    Speaker: Frian Aarsnes, State Authorized Public Accountant, director

    o Since 1988 - Tax administration from public and private side o Since 1989 - International extractive industry from oil & gas and

    mining from the period 1989 through 2005 and international consulting from 2005

    o International economic modelling through heading up (1) corporate finance modelling in Scandinavia up to 2005 and (2) extractive economic modelling in ECON since 2005.

    o International accounting through working as auditor up to 1995, heading up Scandinavian accounting unit till 2005 and supporting USGAAP accounting towards US parent company, international consulting after 2005

    o International taxation through working as tax manager between 1995 and 2005 including participation in Global tax Committe up to 2005 and international consulting after 2005

    o International auditing through working as auditor up to 1995, participating in and organizing partner audits up to 2005 and international consulting after 2005

  • Postulate Taxation of the Extractive Sector is broken

    A few comments on extraction industries and capacity building: - Using people without extractive experience to help tax administrations

    without extractive experience is like having a blind help another blind crossing the street

    - It is useless to have tax administrations work together if the assisting tax administration is not allowed to help building cases this is how

    the tax administrations gained competence themselves, and in order to for knowledge transfer to work, it needs to be done on a case by case basis and not through theoretical lecturing with little transfer value

    - Can developed countries not help developed countries? Be aware that ALL the techniques used by extractive companies have been developed (and used) in developed countries, or by companies that have their home office in developed countries. To think that it is only other developing countries that can assist other developing countries is pointing in the wrong direction. Many of these countries are still not aware of all the instruments being used also against them.

    - Best practice vs Best fit totally agree. Best practices needs to

    be interpreted within their total framework of legal system, institutions involved and economic situation. Best fit is interpreting the needs rather than focussing the practice and seems much more productive.

  • Postulate Taxation of the Extractive Sector is broken

    A few comments on extraction industries and capacity building: - It is true that there is a lot of legal skills missing in developing

    countries, but then there are also missing a lot of economics skills in order to be knowledgeable about how fiscal mechanims works when combined into a fiscal system

    - It is impossible to solve staff retention with higher salaries (only). The reason is that companies can pay 4-5 times more without blinking if they want/need to.

    Want retention? Hire for attitude and train for skills Want innovation? Hire for skills and accept that attitude vary - Research & consultancy is hampered by that there are too much

    compartmentalized competencies fiscal mechanisms are viewed in

    isolation and little work is done on seeing how mechanisms & systems are working together

    - Too little research on extraction potential ECON has 2 large studies

    in the pipeline, one on mining and the other on petroleum, to ensure that academic institutions can get a large enough material to work on extraction taxes and issues (700 mines and 1200 petroleum fields)

    not funded yet, but we are working on it

  • Postulate Taxation of the Extractive Sector is broken

    Comments to the second session on capacity building: - Too much focus on training, not enough on implementation - Talent needs support not enough support for tax administration

    - Not enough understanding in government of how incentives works in oil & gas industry for government incentives are equalled with

    benefits, while incentives should be interpreted as how can we get the companies to do what government wants, ie the typical principal-agent problem

    - Tax policy in lieu of capacity contraints countries are choosing too

    complicated tax mechanisms, very much based on supply-driven advice

    General comments: - Mostly it boils down to the design of the system tax

    administrations do not have the support of the system - The complexity of the solutions are exaggerated it is fully

    possible to solve the problems, but regulators have to (1) have the insight and (2) have the power to implement

  • Taxing the Extractive Sector is Economic governance

    GETTING THE MONEY CONTROLLING COST & REVENUE

    THE ECONOMIC BENEFIT SPLIT

    USING THE MONEY INTRODUCTION IN BUDGET

    DISTRIBUTION

    This presentation

  • Taxing the Extractive Sector is Economic governance

    CONTROLLING COST & REVENUE

    THE ECONOMIC BENEFIT SPLIT

    Tax authorities being able to handle: - Transfer mispricing - Derivatives abuse - Mark-to-market abuse - Tax regulation abuse Cannot be done without the regulator

    The regulator being able to handle: - Simple vs complex tax mechanisms - Normal profits vs superprofits - Gross taxes vs net profit taxes - Normal operations vs sale situations - Country tax system vs the fences around it

  • 9

    Value propositions vs gifts

    A value proposition is an economic benefit that somebody give to somebody else, expecting an economic benefit in return A gift is an economic benefit that somebody give without expecting an economic benefit in return. Many countries think that they give a value proposition to extractive industries when they propose investment incentives, but most of these are mostly gifts. The reason is that when the company sits down at the table there are 2 negotiations going on: - The country think they are negotiating the investment - The company has already decided to invest and are negotiating

    the economic terms and the financing

    Allowing negotiations are the most damaging factor in extractive taxation. All the companies wants is a level playing field. Given the ability to negotiate, they will negotiate to the maximum to be level with other companies.

  • Cooperation (C) vs Non-cooperation (NC) Prisoners dilemma

    Government

    Company

    Loose-Win Corruption

    2 / 8

    Loose-Loose Possible

    0 / 0

    Win-Loose Bad company

    8 / 2

    Win-Win Good company

    5 / 5

    NC

    NC

    C

    C

    NC = (0 * 50%) + (8 * 50%) = 4 C = (2 * 50%) + (5 * 50%) = 2,75

    Company:

  • 11

    Value propositions, gifts and exogenous factors

    A value proposition benefits both parties of a proposal, but a gift is defined as a situation where the recipients gain occurs at the expense of the giver. An exogenous factor like low market prices can make it

    appealing for governments to offer gifts to companies to attract investments

    It is unfortunate if a government offer oil companies gifts to invest when the underlying issue for not investing in the first place does not have anything to do with endogenous factors

  • 12

    Value propositions, gifts and exogenous factors

    Value propositions and policy actions needs to be put into a framework of geology and economics A more prospective country can have more restrictive economic

    terms than a country less prospective needs to be addressed in the terms, not necessarily giving gifts

    The dilemma of diminishing returns and the need to get it right the first time:

    - the tendency is that the most prospective resources are found first, often at a time when countries tax systems (and government officials) are not prepared for extractive industries

  • 13

    Peak

    1 2 3 4 5 6 7 15 30

    Time

    Award

    Discovery

    PDO Field

    Pre-Development Pre License Exploration Development Production Abandonment

    DRILLEX PREDEX CAPEX OPEX ABEX

    Pay Back

    Max Exposure

    Typical oil & gas cash flow

  • 14

    Value propositions or gifts? Examples

    1. 100% investment allowance and interest deduction: Allowing for an interest deduction means that there is something to finance When a country allows 100% investment allowance there is only the equity part

    left to finance once a company has reached tax position (payback) Should a country allow for interested deduction in this situation once the

    company reach payback and can use cashflow from a field or a mine to finance? Allowing interest deduction in this situation means that a country allows tax

    deduction for financing equity with debt

    This is a gift, not a value proposition

    2. Stabilization clauses:

    A stabilization clause is an insurance for the company When somebody takes out an insurance, you pay an insurance premium A stabilization clause without an increased payment means the insurance is for

    free Typical insurance premiums could be: increased CT rate (long stabilization

    clauses) or increased royalty rates (short stabilization clauses) A stabilisation clause with an increased payment is a value proposition, but without the payment the clause becomes a gift

  • 15

    Which tax mechanisms?

    A country should design its tax mechanisms without including companies in the decision process Companies should be allowed to be heard when designing the tax LEVEL of the chosen tax mechanisms Tax mechanisms should: Govern the timing of taxes Affects early or late revenues and collectible amount (increases as

    collection is delayed) Tax level should: Govern the amount of taxes once timed by the tax mechanisms Affects size of collectible amount (should increase as collection is

    delayed)

  • Corporate Tax

    First tier Profit split

    Resource rent taxes

    Tiers of Profit split

    Royalty

    Loss Carry Forward

    Cost oil

    Windfall taxes

    Progressive royalties

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    16

    The main tax mechanisms and their function

    The Quadrant Cross ECON

    Italics = PSA Quadrant 2

    Quadrant 1

    Quadrant 3

    Quadrant 4

  • Framework

    for output interpretation

    Quadrant

    2

    Quadrant

    3

    Quadrant

    1

    Quadrant

    4

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    17

    Dynamic intepretation: Utilizing the Quadrant Cross

    Due to the capital intensive nature of petroleum investments, the opening phase will always be the one with high costs. The expectations on prices will then typically be the main determinant for the subsequent investment behavior of the asset owner.

    ECON

  • Framework

    for output interpretation

    Quadrant

    2

    Quadrant

    3

    Quadrant

    1

    Quadrant

    4

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    18

    1. If prices are low when investing (high costs), then there will be losses and investments tend to be taken over time (not investing fully from the beginning).

    2. Once reaching payback, unit costs usually go low relative to prices.

    3. Over time, prices tend to go higher if they were low previously, creating

    super profits.

    4. As prices increases, costs

    tend to go up due to higher demand, reducing margins in the long run.

    Dynamic intepretation: Utilizing the Quadrant Cross

    ECON

  • Framework

    for output interpretation

    Quadrant

    2

    Quadrant

    3

    Quadrant

    1

    Quadrant

    4

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    19

    4. Low prices will tend to put pressure on the companies to reduce investment and costs in order to stay alive in the competition.

    3. Over time, prices tend to go lower if they were high previously, reducing super profits.

    2. Once reaching payback, unit costs usually go low

    relative to prices

    1. If prices are high when investing (high cost), then the

    companies will tend to take the full investment in order to reach

    payback as fast as possible

    Dynamic intepretation: Utilizing the Quadrant Cross

    ECON

  • The Quadrant Cross ECON

    Analysis tax systems the Quadrant Cross tool

    Revenue collectors

    Safety valves

  • Quadrant 1 and 2 caters to the below normal to normal profits and where Quadrant 2 tax mechanisms is supposed to catch the largest revenue while Quadrant 1 is a safety valve for extremely low price levels

    Below normal to normal profits

  • 22

    Quadrant 3 and 4 caters to the above normal profits and where Quadrant 3 tax mechanisms is supposed to catch the largest revenue while Quadrant 4 is a safety valve for extremely high price levels

    Higher than normal profits

  • Investments make for high costs in the beginning, resulting in losses to carry forward against future revenues

    Extractive companies will often be in all quadrants

  • In low price periods the company will start paying corporate taxes when losses are finished

    Extractive companies will often be in all quadrants

  • When prices increases resource rent taxes will capture the resource rent when profits go above normal

    Extractive companies will often be in all quadrants

  • But few countries have tax mechanisms available that gives the correct incentives to save costs when costs starts to increase

    Extractive companies will often be in all quadrants

  • Oppositely, when investments are done in high price periods, few countries have mechanisms to tax these companies

    Extractive companies will often be in all quadrants

  • When investments are paid back resource rent taxes will start capture the resource rent

    Extractive companies will often be in all quadrants

  • When investments are paid back corporate taxes will also start accruing, but often later as there may be cost thresholds on resource rent taxes, while this is normally not the case in corporate taxes

    Extractive companies will often be in all quadrants

  • When prices go lower companies will tend to have aquired a high cost base already and go into losses, or they may go to reinvestments in order to avoid getting into tax position, viewing tax as a cost.

    Extractive companies will often be in all quadrants

  • Civil law vs common law: normal operations vs sales

    31

    Source: ECON Oil & Gas

  • The limits of institutional design?

    32

    Source:The Limits of Institutional Design in Oil Sector Governance, 2010

  • Different solutions for different situations?

    33

    Source:The Limits of Institutional Design in Oil Sector Governance, 2010

  • Type of tax system and ability to collect taxes ECON

    130

    High

    Special

    taxes on CT with

    Windfall profits 100 %

    taxes capital

    CT with allowance

    accellerated

    depr

    Medium

    CT with Participation

    slow depr

    PSC with No ring-fence

    not cost oil

    PSC with

    low cost oil

    Low Royalties

    Signature

    bonuses

    Front-end Neutral tax Back-end

    loaded tax systems loaded tax

    systems systems

    Ab

    ility

    to c

    olle

    ct t

    axe

    s

    Type of tax system

    Ring-fence

    Primary concern of MNE's can be summed up in the following items: 1. Minimum uncertainty = Maximum stability of factors influencing the investment, including the fiscal system 2. Shortest possible payback-time for the invested amount including profits 3. Least costly way of repatriating investment and profits

  • Best practices

    Base conditions 1. A functioning legal system 2. Ownership is protected from abuse of government

    Best practices: 3. A country needs to decide its tax system itself ... but the

    elements in the tax system must work together - too seldom are the fiscal mechanisms calibrated together 4. The borders AROUND a tax system needs to be the same

    though in order to avoid base erosion and profit shifting (BEPS) - too often the borders around the tax system is forgotten

  • 36

    The fence around the tax system

    Due to the fact that many governments have not thought about how to protect their tax revenue, companies are in a position to exploit the level of taxes paid even though the fiscal system uses very sophisticated tax mechanisms.

    A country needs to

    decide on its tax system

    itself ...

    ... but the borders around the tax system consist of the same elements that needs to

    be addressed by all countries

  • The fence around the tax system

    37

    The fence around a countrys tax system needs to be the same

    whatever the tax system a country has

    A country needs to

    decide on its tax system

    itself ...

    Withholding taxes on all non-transactions ... but not on after-tax dividends!

    Derivatives in separate tax base

    Symmetrical capital gains

    taxation

    ... but the borders around the tax system consist of the same elements that needs to

    be addressed by all countries

  • Possible to fix most issues in tax systems

    38

    Capital Gains symmetrical treatment Derivatives move derivatives into

    separate tax base (separate from the tax base from mining or oil & gas) Withholding (avoiding tax havens) create a withholding tax

    system that incentivice companies to declare profits & dividends Mark-to-market in-country ownership Transfer mispricing transparency, homogenous

    taxation Procurement abuse checking for rebates

  • Country developments

    With the economic upturn for Africa, governments are getting bolder with respect to taxation, to such an extent that it is tipping over where Africa was previously taxing lower than average, one is now going in the direction of taxing above average

    A lot of talk about changing fiscal systems and renegotiating contracts forgetting that early companies helped spur the countries extractive sectors. It is perfectly allowable to treat companies that are entering the country later different from companies that are entering the country early.

    Focus is mainly on resource rent taxation, and few countries are paying attention to their entire tax systems, leaving the doors wide open for massive abuse

  • Corporate Tax

    First tier Profit split

    Resource rent taxes

    Tiers of Profit split

    Royalty

    Loss Carry Forward

    Cost oil

    Windfall taxes

    Progressive royalties

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    40

    Country developments attention on resource rents

    Quadrant 2

    Quadrant 1

    Quadrant 3

    Quadrant 4

    Most of the efforts is on increasing taxation

  • Industry developments

    Lack of resources has led to investments in amongst other Africa. It is this factor, not the investment incentives that has led to the upturn in Africa. Chinas run for securing resources has led to a fierce competition.

    Industry is working towards - Reducing the effect of taxes thresholds to resource rent

    taxes - Removing effective tax mechanisms royalties - Avoiding effective tax mechanisms windfall taxes and

    progressive royalties Industry is supporting less effective transparency mechanisms

    above more effective ones - Industry supporting voluntary mechanisms like EITI - Industry not supporting obligatory mechanisms like

    (extended) country-by-country reporting

  • Corporate Tax

    First tier Profit split

    Resource rent taxes

    Tiers of Profit split

    Royalty

    Loss Carry Forward

    Cost oil

    Windfall taxes

    Progressive royalties

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    42

    Industry developments attention on reducing damage

    Quadrant 2

    Quadrant 1

    Quadrant 3

    Quadrant 4

    Reducing effects of

    Removing Avoiding introduction

  • Multinational organizations

    OECD has its main focus on BEPS (Base Erosion and Profit Shifting). However, effective mechanisms are hindered by that tax havens are part of OECD.

    Information exchange agreements with many tax havens is regarded by many as a success, but this measure has almost no impact on multinational companies, including extractive industries. This measure only works against individual citizens who is using tax havens to keep fortunes away from tax adminstrations.

    IMF has acknowledged, at least in part, the issue of challenges to the tax administrations of focussing only on net profit taxes. Royalties has come back on the agenda, and the organization is still searching for more effective resource rent taxes.

    World Bank has recognized implementation support as an important element as the success of such initiatives as ATAF and tax administration cooperation on a bilateral basis

  • Corporate Tax

    First tier Profit split

    Resource rent taxes

    Tiers of Profit split

    Royalty

    Loss Carry Forward

    Cost oil

    Windfall taxes

    Progressive royalties

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    44

    Multinational organizations attention on resource rents

    Quadrant 2

    Quadrant 1

    Quadrant 3

    Quadrant 4

    Focus on resource rent taxes and the borders around tax systems (BEPS)

  • Independent consultants

    Widely differing agendas Some focus on the functionality of the ordinary tax systems Some focus on the functionality of extractive taxes Some focus on the fences around tax systems Some focus isolated on promoting certain mechanims True research into what works and what does not work in

    extractive industries are to a main degree still missing A lot of mechanisms that is known to work are sometimes

    thrown out (like royalties) or disregarded (like windfall taxes and progressive royalties) in order to be aligned with the directional approach of best practices, without recognizing that the best practices may stem from industry pressure to remove effective mechanisms.

  • Corporate Tax

    First tier Profit split

    Resource rent taxes

    Tiers of Profit split

    Royalty

    Loss Carry Forward

    Cost oil

    Windfall taxes

    Progressive royalties

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    46

    Independent consultants no coherent efforts

    Quadrant 2

    Quadrant 1

    Quadrant 3

    Quadrant 4

    Some focus on resource taxation

    Little attention to quadrant 4 taxes

    Some focus on royalties, but

    ambiguous approach

    Some attention to widening the

    tax base to other than extractives

  • NGOs mainly focussing on the fences

    NGOs has taken on the agenda of transparency and have been behind initiatives like - EITI (Extractive Industries Transparency Initiative) - Country-by-country reporting (US Dodd-Frank, EU regulative) - Extended country-by-country reporting (Norway)

    Focus is on the massive leakages from extractive industries

  • Corporate Tax

    First tier Profit split

    Resource rent taxes

    Tiers of Profit split

    Royalty

    Loss Carry Forward

    Cost oil

    Windfall taxes

    Progressive royalties

    HIGH COST

    LOW COST

    HIGH PRICE LOW PRICE

    48

    NGOs focus on the fences: solution transparency

    Quadrant 2

    Quadrant 1

    Quadrant 3

    Quadrant 4

    Tra

    nspare

    ncy

    NGOs not focussed on individual tax mechanisms

  • ECON Management Consulting Stavanger: Kirkegaten 3 4006 Stavanger Norway Oslo: Akersgaten 1 0158 Oslo Norway

    Frian Aarsnes Director +47 99 23 92 95 [email protected] Andrew Rendall Senior economist +41 78 708 39 94 [email protected]

of 49/49
ICTD – Extractive Industries Workshop 7 th December 2014 Frian Aarsnes State Authorized Public Accountant Director 7. December 2014
Embed Size (px)
Recommended