Alistair Watson

Fiscal Affairs DepartmentInternational Monetary Fund

Key Issues in Natural Resource Taxation in Developing Countries

RESOURCE MOBILIZATION IN SUB-SAHARAN AFRICA

Nairobi, Kenya, March 21-22, 2011

“There are few areas ofThere are few areas of economic policymaking in which the returns to good

decisions are so high – anddecisions are so high and the punishment of bad

decisions so cruel – as in the management of natural

resource wealth”

PrefaceDominique Strauss-Kahn

Managing Director, IMF

2

Diverse Experience so far…Diverse Experience so far…

Receipts from Natural Resources, averages 2000–07

90

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p , g(selected countries, percent of government revenues)

60

70

80

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Significant PotentialSignificant Potential

• Only 20% of Africa’s natural resources• Only 20% of Africa s natural resources discovered so far (Collier)

• If correct flows from natural resources may• If correct, flows from natural resources may dwarf other sectors

P i l f T f i P j• Potential for Transformative Projects– Oil: Ghana, Uganda, Niger, (Sierra Leone? Liberia?

Tanzania?)Tanzania?)

– Iron Ore: Guinea, Liberia; Sierra Leone; Tanzania

– Nickel: Tanzania, BurundiNickel: Tanzania, Burundi

– Uranium: Niger, Tanzania, Namibia4

Mobilizing Revenues from Natural Resources

1 Id if h1. Identify the resources2. Allocate rights3. Design the fiscal regime4. Administer the fiscal regime5. Manage the revenues

• All of these need to be done right• Focus today on (3) - resource tax design• Focus today on (3) resource tax design

What’s So Special About Resources?What s So Special About Resources?

• Size of sector (even individual projects) relative to the• Size of sector (even individual projects) relative to the economy

• Tax revenue is the central benefit to host country

– Leveraging other economic development an ongoing challenge

• High sunk costs long production periods• High sunk costs, long production periods

– Create ‘time consistency’ problem

• Substantial rentsSubstantial rents

– The ideal of a non-distorting, immobile tax base!

• International considerations loom large

– Foreign tax rules matter

– Tax competition

UncertaintyUncertainty

• From geology technology price volatility• From geology, technology, price volatility…

14,000

Copper (real 2010 prices)

130

Crude oil (real 2010 prices)

8,000

9,000

10,000

11,000

12,000

13,000

onne80

90

100

110

120

el

3,000

4,000

5,000

6,000

7,000

,

$US

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etric

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50

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per b

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0

1,000

2,000

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20100

10

20

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

• …and political risk

Forecasting Prices is Hard

U.S. Department of Energy Annual Energy Outlooks (AEO) 1982-2004 (2006 U S Dollars per Barrel)

Forecasting Prices is Hard…

80

90

100

(2006 U.S. Dollars per Barrel)

AEO 1982

50

60

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r ba

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AEO 1985

10

20

30

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$

AEO 1991

AEO 2000AEO 1995

AEO 2004

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10

Sources: U.S. Department of Energy Outlook (1982,1985,1991, 1995, 2000 and 2004); and IMF World Economic Outlook (2003,2004,2005,2006,2007, 2008, and 2009). After Ossowski et. al. (2008)

Note: Solid lines on the left chart are spot WTI oil prices, on the right chart are WEO average of WTI, and Fateh. The dashed lines are price projections.

What Else?What Else?

• Asymmetric informationAsymmetric information

Few of these are unique to resources—they’re just bigger. gg

What is unique is:

• ExhaustibilityExhaustibility

– Opportunity cost of extraction includes future extraction forgoneg

– Views differ on how important this is in practice

– Ideally: recognize revenues as transformation ofIdeally: recognize revenues as transformation of finite asset in the ground into financial asset

Menu of MechanismsMenu of Mechanisms

• Taxes on inputs – import duties excises• Taxes on inputs import duties, excises

• Taxes on revenues – royalties

fi i• Taxes on profits – corporate income tax

• Taxes on rent – resource rent tax

• State equity participation

• Many variations on each themeMany variations on each theme– progressive royalties, windfall taxes, variable

income tax, free equity vs. carried equity, etc.income tax, free equity vs. carried equity, etc.

• Production sharing (petroleum) 10

Economic RentEconomic Rent

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Resource Rent Tax – “Neutral”

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Rent TaxesRent Taxes

• Various possible forms, with differing revenue paths p , g pand risk sharing– Brown tax, Resource Rent Tax, ACE*

• For true neutrality, relief required for exploration costs and loss-making projects

• Government taking on risk and deferral of revenue• Government taking on risk, and deferral of revenue• Norway perhaps closest today• Australia’s proposed RSPT; now MRRT• Australia s proposed RSPT; now MRRT• For a developing country RRT useful, but maybe not

as the primary fiscal sharep y

* Allowance for Corporate Equity

How Important Is Progressivity?How Important Is Progressivity?

...in sense of government’s share being larger the...in sense of government s share being larger the higher are prices/profits/lifetime project return?

• Yes, if government better able to bear risk than , ginvestor– But opposite likely true in many developing countries

• Political pressures may make progressive systems more robust and credible– Long accepted objective in Petroleum fiscal systems

– Increasingly recognized in Mining

Multiple Instruments Neededp

• In order of efficiency taxes on: (1) Rent (2) Profits (income y ( ) ( ) (tax) (3) revenues (royalties) (4) inputs

• Taxes on inputs usually exempted

• Royalties distort but may still have an important role:– Revenue from day 1 of production

– Easier to administer – no need to measure costsEasier to administer no need to measure costs

• CIT usually applied– Create creditable tax and consistent treatment with other sectors

• Common framework: (1) Royalty + (2) CIT + (3) rent capture mechanism (RRT)

• But significant diversity in detail• But significant diversity in detail…

Careful Evaluation is CriticalCareful Evaluation is Critical

• Developing countries do not do this well

• Project economic modeling is vital

Four key indicators • Average effective tax rate (AETR): the tax share of net cash flow

discounted at a chosen rate

• Marginal effective tax rate (METR): the tax “wedge” between the g ff ( ) gpre- and post-tax rate of return

• Breakeven price: the output price required to yield a specified post-tax return to capitalp

• Progressivity: E.g. variation of government’s share with project return

plus measures of effects on risk sharing… plus measures of effects on risk sharing

Detail matters

Government share of Total Benefits Discount rate 15 percent2004; 4% Royalty;

Detail matters

30%

35%

40% Tanzania 1997

Tanzania 20042004; 4% gross royalty

00 ; % oya ty;0% equity;

20% Resource Rent Tax

10%

15%

20%

25%

Tanzania 4% royalty2004; 4% Royalty;

0% free equity

2004

Difference 1997 - 2004:15% uplift

0%

5%

10%

10% 15% 20% 25% 30% 35% 40%

P T IRR

Tanzania 4% royalty; 0% free equity

Tanzania 4% royalty; 0% free equity + RRT

1997 terms 75% (2004) versus 100% (1997) debt

Pre Tax IRR

▫ Depreciation rules ▫ Indirect taxes (import duties, VAT)

• FAD’s models can be used for detailed evaluation of fiscal terms changes:

22 April 2010 19

▫ Royalty rates and basis ▫ Government equity participation

▫ Thin capitalization/Debt leverage ▫ Ring fencing

The Pros and Cons of AuctioningThe Pros and Cons of Auctioning

• Get investors to compete with each other not• Get investors to compete with each other, not the government

• Use auctions to soak up perceived rent• Use auctions to soak up perceived rent

• But, requires a competitive situation with h lenough players

• Design matters—including bid variables

• Implementation matters as much (or more)

• Why so little used for minerals?Why so little used for minerals?

Set Generally Applicable TermsSet Generally Applicable Terms

• Developing countries often end up negotiating• Developing countries often end up negotiating deals for major projects case by case– Lack of legal framework and effective fiscal regime– Lack of legal framework and effective fiscal regime

– Huge burden on technicians and decision makers

An uneven contest– An uneven contest…

• FAD advice: set generally applicable terms and id b ti tiavoid case by case negotiation

– Cross reference generally applicable terms (e.g. t l ) i d l t ttax law) in development agreements

21

Administration— is it That Hard?Administration is it That Hard?

• Technical complexity, new to administratorsTechnical complexity, new to administrators

• Dealing with complex MNCs always hard

• Use reference commodity prices• Use reference commodity prices

• Do the simple things right; exercise audit rights!

• Royalties not as easy to administer as may seem• Royalties not as easy to administer as may seem…

• … But rent taxes maybe not as hard

• Building capacity:• Building capacity:– Specialize – Large Taxpayer Office

– Hire in expertsHire in experts

Stability and CredibilityStability and Credibility

• Takes years to develop (Norway)Takes years to develop (Norway)

• Easy to lose (Australia?)

• But credibility does not mean no change (UK )• But credibility does not mean no change (UK )

• Potential for future discoveries may help

• Fiscal stability agreements?• Fiscal stability agreements?– Can be over-generous and create administrative problems

– Effectiveness unclear—renegotiation always possibleEffectiveness unclear renegotiation always possible

• Some designs more credible than others– Flexibility and Progressivity?y g y

The Book…The Book…

• Overview: Concepts and low pincome country issues

• Sectoral issues (oil, minerals, )gas)

• Special topics (evaluation, RRT, state participation, , p p ,auctions)

• Implementation( d i i i i i l(administration, international tax)

• Stability and credibilityStability and credibility

AimsAims

• Consolidate and take forward current knowledge inConsolidate and take forward current knowledge in the field (topic fell out of fashion).

• Link public finance and resource taxation literaturep

• Wide audience: academics, practitioners, companies, government and civil society.g y

• Best practice? No – concentrates on principles, criteria and methods to apply in different circumstances.

• Combines theory and practice

IMF (FAD) Actively EngagedIMF (FAD) Actively Engaged

2626

ThanksThanks

The Taxation of Petroleum and Minerals:

Principles, Problems and Practice

Edited by Philip Daniel, Michael Keen,

and Charles McPherson

Routledge / IMF, 2010

www.imfbookstore.org

www.routledge.com/978-0-415-56921-7www.routledge.com/978 0 415 56921 7