Resource Taxation: Matching Design with Administration Lusaka Norad Workshop 18 and 19 th April, 2012 Charles McPherson and Alistair Watson With 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

Production costs/price P Achieving Efficiency Using Profits Taxation (1) Mine production Q* Tax on profit Profit after tax Marginal cost per unit of output

Tax F Production costs/price P Inventory of mines Achieving Efficiency Using Profits Taxation (2) Not viable Viable Long term expected price Profit after tax Mine C unit cost D E Mine A unit Costs Mine B unit costs x*

Production Marginal Production costs/price 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 Production average unit costs/price P Inventory of mines Achieving Simplicity (at the cost of efficiency): The Case of Royalties (2) Not viable Viable Long term expected price Mine C D E Mine A Mine B R x*y

Progressivity and Regressivity 9 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 toProduction Price change Costs Timing of cash flows Cost of capital Production (daily or cumulative) YesNo PartlyNo Price (price caps or base prices) NoYesNo Revenue (price and production) Yes NoPartlyNo Cost recovery (uplifts and write-off rates) No YesPartly Simple indicators (location, vintage, and so forth) Partly No Variable Income tax Ratio of taxable income to revenue Yes No Rate of return (ROR)Yes 11

Problems With Proxies (2) They are proxies… Partial, inaccurate, measurement of profitability Likely to quickly become outdated Simplicity proves an illusion.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 RoyaltiesFixed rates Limit differentiation between minerals (~3 categories) Base = FOB port of export (or gross value?) Use benchmark prices for valuation Disallow hedging Corporate Income tax (CIT) Simple straight-line depreciation rules - two or three categories of capital only Segregate (or disallow) hedging Limit debt (thin capitalization) Separate ring fencing by project [or contract area] Rent captureCaptures increased share of actual realized profit Uses 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

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