the fiscal terms and resource revenue collection
TRANSCRIPT
The Fiscal Terms and Resource Revenue Collection
2
1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally-held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7- What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
Stylized Mining and Gas Project Timeline
Project Timeline
Revenue
Capital Costs
Operating Costs
Exploration Costs
Source: Revenue Watch Institute
4
Stylized Oil Project Timeline
Source: Revenue Watch Institute
Oil depleted faster than minerals, payback period is shorter, opex over the life of the project lower -> more profitable than mining , generally speaking
5
High Potential For Increase In “Rent ”
Source: Revenue Watch Institute
“RENT” or “SUPER/EXCESS
PROFIT”
Stylized Project Breakdown
Total Costs
Minimum Return
Rent
Why is Extractive Industry specific ?
• Lengthy exploration period with no revenue
• High Capital expenditure making the capital captive and not transportable
• High probability of social and environmental damage
• Cyclical revenues because of volatile commodity market
• Minerals are finite and belong to the State or the land owner
• Long life of mine implies potential for regime changes and policy instability
•Tremendous potential for high “rent” (Financial returns above those a company requires to invest ). The rent increases with the quality of the mineral deposit
Extractive Industry: A Specific Sector With a Specific Tax Policy
Calls for a resource specific taxation
• Special Tax Treatments to encourage exploration - always demanded and considered justified by companies
•Use of taxation incentives for investment in communities and protection of the environment
• Request for use of profit-based taxes by the investors
• Royalty: price of the right to use the land belonging to either the national state / local government or the landowners (US) + immediate revenues
•Need of a progressive fiscal regime that self-adjusts to circumstances and profitability to ensure stability of the system
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1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7- What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal design ?
8
Main Types of Tax Instruments
• On Dividends for foreign shareholders- common and encourage re-investment in the country
• Most states apply a standard national corporate rate in the range of 20% to 35% of profits
Withholding Tax on Dividends
Corporate Income Tax Investment
Credit/ Capital allowance
• A percentage of the capital expenditure that is tax deductible
Loss and Carry Forward
• An accounting technique that applies the current year's net operating losses to future years' profits in order to reduce tax liability
Royalty• Imposed on value of mineral sales (ad
valorem) or on production volume (unit based).
• The value can be defined in different maners (FOB, CIF, mine – gate, netback )
Depreciation and Amortization (D&A)
• Accounting mechanism to spread out the capital expenditure over many years-> tax deductible and investment incentive
1. The Rate: 5% royalty 30% income tax rate 10% equity share
2. The Base The number against which the rate is applied. Revenue-based? Production – Based? Profit - Based? Need of a clear definition : gross revenue? Net revenues? Profit
including depreciations? Before depreciation?
3. TimingFor developing countries funding growth and development, timing
matters.Timing also relates to the risk of different revenue streams.
Elements of Fiscal instruments
Room for manipulation
Room for political
economy
Importance of the Tax Base !
- Royalty Rate of 3% for Copper- Copper Sold at Export Point at $7500/Ton - Transport and Processing Costs of $500/Ton
Royalty per Ton under Net Back= rate * (gross – costs)= 3% * (7500 – 500)= 3% * 7000= $210
Royalty per Ton under Gross= rate * gross = 3% * 7500 = $225
How to manipulate the royalty base ?
Room for manipulati
on
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Complexity of the Definition of the Tax Base
Source: World Bank
12
Complexity of the Definition of the Tax Base
Fiscal Instruments – A Common Example In Extractive Industries
Gross Revenue To Investor
Pre- Tax Profit (EBT)
After-Tax Profit
Inv.’sDividend
W/Htax
Government Revenue
Gross Revenue From Oil, Gas or Mining (P*Q)
Royalty
Production Cost – “OPEX”
Profit Tax
Govt. Equity
Reserves
[W/H = withholding]
Investor Return
Source: Revenue Watch Institute
Includes financial cost and depreciations
Dividends
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Fiscal Regime in the Oil Sector is often Different from Mining
Mining mostly here
15PSCs have never taken off in the mining sector … why?
In PSC, contractor receives a share of the proceeds from Cost Recovery and Profit Split
In PSC, government receives a share of the proceeds from Profit Split and taxes paid by the contractor on its take
Profit Sharing – How Does It Work?
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1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7- What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
17
Effective Tax Rate (ETR)
Definition: Total government taxes Cumulative Pre-tax profit
Comparing the fiscal regimes based on this ETR in a selection of countries that compete for mining investment (“peer countries”) helps assess the fairness FOR BOTH PARTIES of the fiscal regime
Internal Rate of Return (IRR)
Definition : Makes the positive cash flows (project revenues) equal to negative cash flows (initial investments)
- Must be above the cost of capital
- The higher the better!
- Can be used to rank several prospective projects a firm is considering.
- Can be increased by leverage hence the interest of thin capitalization
Assess the profitability of the project
Assess what is called theGovernment Take in the project
Fiscal Regimes Are Assessed Against 2 Main Indicators Revealed by the Fiscal Model
USED BY THE
INDUSTRY
USED BY POLICY
MAKERS AND
ADVISERS
ETR=
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When commodity prices go up and/ or project costs go down, everybody benefits, but
the percentages may change.
Government Share (Gov Take)
Contractor ShareTotal Net Profit
$670 Million$330 Million$1 Billion
- 67%
$1.5 Billion
Government
Contractor
Low Oil Prices or High Cost
situation
High Oil Prices or Low Cost
situation
33%
67%
37%
63%
$945 Million$555 Million
Source: Adapted from Daniel JohnstonWHY WOULD IT HAPPEN?
- 33%- 63%- 37%
The Need For a Progressive Fiscal Regime
From B. Land, Taxing the Minerals Industry in Turbulent Times, 2009 (citing PWC report, “Mine: As Good as it Gets?” 2008)
Prices, Internal Rate of Return, Rent..
HOW TO FIX THIS SITUATION ?
Easy First Step But Not Optimal : Progressive vs. Flat
Royalty RatesProgressive Royalty Rate
Price Rate Total Royalty Take
$100 7% $7
$200 8.5% $17
$300 9% $27
Flat Royalty Rate
Price Rate Total Royalty Take
$100 7% $7
$200 7% $14
$300 7% $21
NOT TIED TO PROFITABILITY or ACCUMULATED PROFITS AND
CAN BE DETERRENT
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Reminder: Costs Go Down Naturally
Source: Revenue Watch Institute
“RENT”
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What Would Be Such a Progressive Tax?
Resource Rent Tax Rate
Project Internal Rate of Return
20%
50%
25% 45%
Gradual increase
Threshold
Resource Rent Tax: Highly tied to profitability and to accumulated cash flow
0%
If suddenly the net cash flow is negative again, the RRT stops kicking in
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Can the fiscal regime carry one more input tax and still remain viable for the investor?
Resource Rent
Tax
Income Tax
Royalty Tax
Withholding Tax
Timing of Different Fiscal Tools
Source: Revenue Watch Institute
Timing matters for developing countries
Optimal Progressive Taxation
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Qualities of a progressive fiscal regime?
• Captures the rent
• Does not distort investment decisions
• Self-adjusts to richness of the deposit, price, cost and risk = capable of accommodating wide ranges of profitability
• Avoids the need to change tax regime (fiscal reforms) according to market and geological conditions
BUT! Almost NO African countries have progressive taxation!
Less Optimal Progressive Taxation
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Other less progressive ainstruments
• Windfall profit tax (often price-based)
• Variable income tax
• Other sliding-scale instruments
Less progressive but maybe more adapted to the tax administration capacity
27
Responsiveness of Proxies to Profitability
Source: IMF
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1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7 - What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
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Mirage Of Equity Participation
WHY CAN WE SPEAK ABOUT A MIRAGE?
EQUITY PARTICIPATION
FORMS
So-called “free” equity
Paid-up equity
Equity in exchange
for a non-cash
contribution
Paid-up equity
for local ownership
Carried interest
Tax swapped for equity
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The Mirage – WHY?
• Can be costly option. (ex: Nigeria)• Possibly, dividends never paid (widely experienced )• Possible conflict of interest ( government’s role as regulator vs equity shareholder. ) (ex: Mozambique)
• Economic: share in any upside of a project,
• Non-economic : nationalistic sentiment (DRC), transfer of technology and know-how (South Africa), direct control over project development (Guinea)
Motivation for state equity
Problems
• Economic impact of an equity share can in principle be replicated by tax instruments.
THE IRONY
The government is often better off by focusing on taxing and regulating a project rather than being directly involved as an equity participant.
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State Equity Problems Can be Exacerbated in the Presence of a SOE
Problems of NOC in general:
- Are assigned contradictory objectives:
- Providing employment (China, Russia)
- Providing fuel subsidies (Saudi Arabia, Venezuela)
- Providing infrastructure (Nigeria – Angola : pipelines)
- Foreign policy objectives (China)
- Answer government’s cash demand (Mexico)
- And…. Be the National Oil Company!
32
1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7- What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
Capital Gains Taxes and Indirect Transfer
There is no direct transfer or “assignment” of the rights in the project. A new agreement (e.g., mining license) is not signed.
There is a change in control (“indirect transfer”) , happening offshore of the company holding the right/ mining license
Change in control = sale of shares of either the company holding the license, or of one of the companies in the chain of ownership of that company (e.g., the holding company/ultimate parent company) (sales happening somewhere in the beneficial ownership)
34
A Famous Case from Mozambique
Riversdale Mining Limited
Rio Tinto
Riversdale Energy
AUSTRALIA – STOCK EXCHANGE
MAURITIUS
Riversdale Mozambique Limitada
MOZAMBIQUE
Rights to the Coal project
Owns the companyBought
Owns the right
On the grounds that Riversdale Ltd holds
underlying assets which are in the
country, GoM is claiming a CGT
35
The Regulatory Solution to CGT
Indirect transfers should also be covered by CGT regs All license holders should disclose “beneficial ownership” Prior notice of such transactions + with all relevant documents
should be given to the Government Sometimes restriction of scope of application (% of mineral assets
ownership or % of shares transferred) Enforcement: tax withheld from the purchase price. “Lien” on the
concession agreement and/or other assets of the local company to cover defaulted tax obligations. Shares of the local company would be considered to be held in trust for the government.
Ability to tax depends on DTA – that might only authorize taxation on residents or taxation on direct transfer
Challenge: not easy to determine to what extent the value of the non-resident shares is reflected by an increase in value the host country’s assets when the non-residents owns several assets!
36
1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7- What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
37
Different Investment Incentives
Corporate income tax incentives
• Tax holidays or reduced tax rates
• Tax credits
• Investment allowances
• Accelerated depreciation -> tax base – transfer tax burden but doesn’t
wave it
• Reinvestment or expansion allowances
Other tax incentives
• Exemption from or reduction of withholding taxes
• Exemption from import tariffs
• Exemption from export duties
• Exemption from sales, wage income or property taxes
• Reduction of social security contributions
Financial and regulatory incentives
• Subsidized financing
• Grants or loan guarantees
• Provision of infrastructure, training
• Preferential access to government contracts
• Protection from import competition
• Subsidized delivery of goods and services
• Derogation from regulatory rules and standards
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Text
• No companies had paid income tax until 2011 besides Anglogold Ashanti, 10 years after starting production
• Barrick Gold 97 million$ between
2004 and 2007 but 0 income tax
TANZANIA
• 1992 international copper prices 2280$/ton production 400 000 tons: In coffer: 200 m$
• 2004 copper price 2868$/ton production 400 000 tons: In coffer : 8m$
ZAMBIA
Text
Developmental Impact of Tax Incentives
Tax Incentives and Loopholes
Lack of ring-fencing
Thin capitalization
Transfer Pricing
In addition to progressive decrease in tax rates AND tax base
REVENUES COLLAPSED!
70’s-80’s
2000’s
Washington consensus
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Do Countries Need Tax Incentives to Attract Investment?
Mc Kinsey, 2009: “popular incentives, such as tax holidays (..) serve only to detract value from those investments that would likely be made in any case”
IMF, 2009 : “ tax incentives in sub-Saharan Africa are now used more widely than in the 80’s with more than two thirds of the countries in the region providing tax holidays to attract investment. Such incentives not only shrink the tax base but also complicate tax administration and are a major source of revenue loss and leakage from the tax economy
DOES THIS ISSUE ONLY AFFECT AFRICA?
IF no Ring Fencing, Government loses !
Project 1 Project 2
- Gross Revenue $750 - Gross Revenue $ 5000
- Total Costs $4000 - Total Costs $ 7000
- Net Revenues $3500 - Net Revenues - $ 2000
- Tax (@30%) $1050 - Tax (@ 30%) $ 0
Project 1+2 (NO Ring-fencing)– Gross Revenues: $12500
– Total Costs: $11000– Net Revenues: $1500– Tax (@ 30%) = $450
If the law is silent, you just don’t apply ring fencing of profits and losses!
42
Transfer Pricing Practice and How To Limit It?
HOW TO FIX IT ?TRANSFER PRICING PRACTICE
• Definition: prices charged for cross-border transactions between related parties
• WHAT DO YOU NEED TO SUCCEED ( as a company) ?
• The creation of an affiliate entity
• To whom you sell exports at below market price (=‘transfer price’)
• To whom you charge imports/ leasing at above market price (=‘transfer price’)
• From whom you borrow at above market interest rates to highly leverage projects
• Regulatory Solution!
Law/ Contract: 1) require arms-length basis
transactions between related parties
( article 9 of UN and OECD Models for DTA)
Difficulty : for some specialized goods and services , difficult to determine what exactly is a fair market price.• Requires closer monitoring• More reporting• Requests for comparable
transactions• Cooperation with tax
authorities of home countries
2) impose a cap on theallowable debt-leverage of a project
$10 bn/ year left Africa between 2002 and 2006 as a result of transfer pricing
DISHONNEST BUT LEGAL
!!
THIN CAPITALIZATION
Transfer Pricing (2)
Example:
Parent(UK)
Sub1(British V.I.)
Sub2(Angola)
Sub3(UK)
Purchase of Inputs: $100 Sale of Minerals: $120
Fair Market Value: $50 Fair Market Value: $150
Taxable Profit: $20
Taxable Profit (fair market value): $100
Source: Revenue Watch Institute
Transfer Pricing Practice – Example
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The UN Model Tax Convention Article 9(1)
“Where:(a) an enterprise of a Contracting State participates directlyor indirectly in the management, control or capital of an enterpriseof the other Contracting State, or(b) the same persons participate directly or indirectly in themanagement, control or capital of an enterprise of a ContractingState and an enterprise of the other Contracting State,and in either case conditions are made or imposed betweenthe two enterprises in their commercial or fi nancial relationswhich diff er from those which would be made between independententerprises, then any profi ts which would, but for those conditions, have accrued to one of the enterprises, but, by reason of these conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly”.
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A concrete example
Assume a corporation P (parent) manufactures automobile seats inCountry A, sells the finished seats to its subsidiary S in Country Bwhich then sells those finished seats in Country B to unrelated parties(say, the public at large). In such a case S’s taxable profits are determinedby the sale price of the seats to the unrelated parties minusthe price at which the seats were obtained from its parent corporation(cost of goods sold in the accounts of S, in this case the transfer price)and its expenses other than the cost of goods sold.
If Country A where the seats are manufactured has a tax rate muchlower than the tax rate in Country B where the seats are sold to thepublic at large, i.e. to unrelated parties, then perhaps corporation Pwould have an incentive to book as much profi t as possible in CountryA and to this end show a very high sales value (or transfer price) ofthe seats to its subsidiary S in Country B. If the tax rate was higherin Country A than in Country B then the corporation would have anincentive to show a very low sale value (or transfer price) of the seats toits subsidiary S in Country B and concentrate almost the entire profitin the hands of Country B. Source: UN Manual
46
Applying the Arm’s Length principle (ALP) in practice
• Several acceptable transfer pricing methods exist, providing a conceptual framework for the determination of the arm’s length price.
• All these transfer pricing methods rely directly or indirectly on the comparable profit, price or margin information of similar transactions.
• 5 major transfer pricing methods: Comparable Uncontrolled Price Resale Price Method Cost Plus Profit Comparison Method Profit Split
• Advance Pricing Agreement (APAs): pricing methodologies agreed in advance in relation to certain types of transactions, often called the “covered transactions”. Provide greater certainty for the taxpayer on the taxation of certain cross-border transactions and are considered by the taxpayers as the safest way to avoid double taxation
47
Applying ALP is COMPLEX
Fight against Thin Capitalization: International Practice
US: 1.5:1 debt-to-asset ratio
Australia: 3:1 debt-to-asset ratio
Canada: 2:1 debt-to-asset ratio
Chile: 3:1 debt-to-asset ratio
Liberia: interest + 50% taxable income before interest (or as negotiated)
Peru: 3:1 debt-to-asset ratio
Saudi Arabia: lower of actual interest or interest + 50% taxable income before interest
Sierra Leone: 3:1 debt-to-paid up share capital
South Africa: 3:1 debt-to-asset ratio
Tanzania: lower of actual interest or 70% of taxable income before interest
Zambia: 3:1 debt-to-asset ratio
Malawi: 4:1 debt-to-asset ratio
Mongolia 3:1 debt-to-asset ratio (only applies to related-party debt)
No Thin Capitalization Rule in
Brazil - China - India - Indonesia - Papua New Guinea – many African countries!
Need to clearly
include shareholders’
loans in the definition of
“debt” or “interest”
49
1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7- What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
As a Starting Point : Fallacy of Discussing Individual Fiscal Tools in
Isolation
FISCAL MODELING TO KNOW THE OVERALL FISCAL BALANCE! AND UNDER DIFFERENT SCENARIOS!
Knowing that a royalty is 4%, 5% or 10% will not give you a sense of whether the country is getting a good deal unless you also know how much the country earns from other fiscal tools (profit taxes, bonuses etc )!
Fiscal modeling will tell you that Different Combinations of Fiscal Tools Can Yield the
Same Outcome for the Government
Example 1
Corporate Income Tax as primary tool to extract revenue
Royalty = $10 million
Profit tax = $40 million
Total revenue= $50million
Example 2
Royalty as primary tool to extract revenue
Royalty = $45 million
Profit tax = $5 million
Total revenue = $50 million
52
Financial Modeling: A Tool For Fiscal And Public Investment Policy
WHY Forecasting the revenue flows to the government under different scenarios ?
What long term public investment policy can be funded and planned?
What is the fairness of the current and potential deals?
What is the equitability of the fiscal regime for investors and government?
What is the trade-off between “quick money” through signature bonuses and a higher share of profits ?
What is the efficiency of tax incentives?
If we change the tax regime, what is the impact for the parties?
How does this fiscal regime compare with others?
53
Effective Tax Rate (ETR)
Definition: Total government taxes Cumulative Pre-tax profit
Comparing the fiscal regimes based on this ETR in a selection of countries that compete for mining investment (“peer countries”) helps assess the fairness FOR BOTH PARTIES of the fiscal regime
Internal Rate of Return (IRR)
Definition : Makes the positive cash flows (project revenues) equal to negative cash flows (initial investments)
- Must be above the cost of capital
- The higher the better!
- Can be used to rank several prospective projects a firm is considering.
- Can be increased by leverage hence the interest of thin capitalization
Assess the profitability of the project
Assess what is called theGovernment Take in the project
Fiscal Regimes Are Assessed Against 2 Main Indicators Tested By The Model
USED BY THE
INDUSTRY
USED BY POLICY
MAKERS AND
ADVISERS
ETR=
54
Govt Take= Effective tax rate (ETR)*Percentage
IRR Percentage
846362
5854
5050494846454543434240403737
Burkina FasoUzbekistan Ivory Coast
Papua New Guinea Ghana
Greenland Mexico
Indonesia Tanzania
Kazakhstan Philippines
South Africa Bolivia
Peru China
Argentina Zimbabwe
Poland Chile
Average
3.39.38.910.811.91311.312.212.412.913.513.511.412.312.713.913.512.215
49.2
Copper Mines
Source: J. Otto et al, Global Mining Taxation Comparative Study, Colorado School of Mines
International Benchmarking Comparing Government Take AND Profitability Is Needed To Assess The Fairness Of a Deal
Take a standardized mine model
and apply all applicable taxes for each
country in that one model and
compare the outcomes
Examples of Copper Mines:
Average ETR: 49.2%
for IRRs that are
all below 15%
Important Note On Government Take : Mining Is Not Oil !
Government Take Oil: 60-80%
Government Take Mining: 25-60%
WHY?
In mining, a lot more fiscal incentives, no cartel like OPEC to keep prices up, no progressive fiscal regime, less rent to make
56
1- Why does extractive industry require a special taxation regime?
2- What is this special taxation system?
3- Why do we need progressive fiscal regime?
4- Why can we speak about a mirage regarding locally held equity ?
5- Capital Gains Tax: What is challenging about it ?
6- Do low income countries need tax incentives to attract investment?
7 - What is the importance of fiscal modeling for host countries?
8- What are the main challenges of fiscal regime design ?
57
What Are the Common Goals to Take Into Account in a Fiscal Regime
Design?
Government Take/Overall fiscal balance adapted to level of attractiveness of the mineral/ hydrocarbon deposits
Government Take/Overall fiscal balance competitive with the peer group countries
Government Take not collapsing over time
Government Take/Overall fiscal balance adapted to capacity of the tax administration
58
Source: IMF
What Are the More Country-Specific Objectives?
Tax Administration Capacity and Policy Design
Possible trade-off between progressivity and ease of administrationThe simplest fiscal tools to administer (bonuses and royalties) are
also the least progressive …whereas the most complicated (resource rent taxes) are the most progressive.
“Most complicated” means high risk of leakages in low capacity governments
Possible trade-off between efficiency/credibility and ease of administrationEx: price-based taxes may eventually become untenable and
require adjustment if costs rise disproportionately and thus decrease profit margins
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Policy response?
-> MINIMIZE TRANSFER PRICING-> STANDARDIZE CONTRACTS-> FOCUS ON THE MAIN REVENUE STREAMS -> ELIMINATE MINOR TAXES
DON’T GIVE UP ON PROGRESSIVE TAX REGIMES BUT INVEST IN CAPACITY BUILDING !!