DESIGN AND EVALUATION OF FISCAL REGIMES FOR

EXTRACTIVE INDUSTRIES: AN IMF PERSPECTIVE

Fiscal Affairs Department

USGS National Minerals Information Center

Washington, DC, May 17, 2017

Focus of presentation

• Guiding principles for extractive industries taxation

• The IMF’s Fiscal Analysis of Resource Industry (FARI) methodology

• Overview of fiscal regimes in selected countries

• Reflecting IMF policy advice and capacity building in developing countries

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GUIDING PRINCIPLES FOR EXTRACTIVE INDUSTRIES TAXATION

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Defining the fiscal regime • The combined system of tax and non-tax instruments

used to raise government revenue from extraction activity.

• It includes not only conventional instruments such as royalty and corporate income tax, but also resource rent taxes and production sharing.

• It can include state equity participation which have fiscal effect on the revenue sharing even where held by a commercially operating state owned enterprise.

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Take account of sector characteristics

• Key revenue source for many countries

• Large upfront capital investment, and long production periods

• Pervasive uncertainty

• Potential for substantial (economic) rents

• Asymmetric information

• Extensive involvement of multinationals in some countries… and of state-owned enterprises in others

• Non-renewable resources (exhaustibility is unique) 5

Key source of revenue for many developing countries

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Government Receipts from Natural Resources, averages 2000-2014 (Selected countries, in percent of total revenue excluding grants)

Mining and PetroleumMiningPetroleumPercent of GDP (RHS)

Pervasive uncertainty… in prices

7

0

2,000

4,000

6,000

8,000

10,000

12,000

US$

per m

etric

tonn

e

WEO Copper Price Forecasts 2002-2022(Monthly Prices, 2016 U.S. Dollar per tonne)

Sep 2003 Sep 2004Sep 2005

Sep 2006

Oct 2007

Oct 2008

Oct 2009

Oct 2010

Sep 2011

Oct 2012 Oct 2013

Oct 2014

Apr 2015Oct 2015

Apr 2016Oct 2016

Apr 2017

… and costs

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Source: Federal Reserve Bank of St. Louis

0

50

100

150

200

250

300

350

400

Producer Price Index: Total Mining Industries, 1984=100

Project A Project B

Project C D

E F

Cumulative production

Prod

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pric

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Economic Rent: Return in excess of project costs including minimum required by investor

P1

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… but potentially high economic rents

Not viable

Viable

Long term expected price

Extensive involvement of multinationals and state-owned companies…

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• Top 40 split between traditional and emerging market companies

• In 2016 three of the 10 largest mining companies were state-owned

• Other significant state-owned companies, such as Chile’s Codelco, which is the largest copper producer in the world.

-

20,000

40,000

60,000

80,000

100,000

120,000

BHP Billiton Rio Tinto ChinaShenhuaEnergy

Company

Coal India MMC NorilskNickel

Glencore Vale GrupoMéxico

Potash Corp. SaudiArabianMining

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Market Capitalization, Selected Mining Companies, FY 2015

State-Owned

So what should fiscal regimes aim at?

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• Avoid deterring the investment!

• Maximize present value of government revenues…

• …combined with early and dependable revenue

• Improve adaptability (although higher progressivity means more risk)

• Provide ease of administration (for authorities) and compliance (for taxpayers)

Three main fiscal schemes (sometimes blended)…

1. Contractual, including production sharing or service contracts

2. Tax and royalty, with licensing of areas

3. State ownership or participation

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A wide range of possible instruments

• Bonuses (with bidding) – Rare in mining but sometimes used in mature jurisdictions

• Royalties – Distort extraction (and, hence, exploration) decisions – Can be used in principle to influence extraction path – Revenue from start of production

• Corporate income tax

– Tax the normal return on equity – Ring-fencing rules – International tax issues (Double tax treaties, withholding taxes)

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• Rent taxes – Non-distorting in principle… – …but usually combined with distortive taxes – Many forms, with different timing of receipts

• Production sharing (mostly used in petroleum) – Various mechanisms are available – Can secure revenue from start of production, and could be

designed to increase revenue as profitability increases

• State participation – Can help resolve asymmetric information – But potential governance issues and fiscal costs

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A wide range of possible instruments (2)

What is adopted in practice?

• Fiscal regimes vary greatly among countries (results from 2012 survey) Fiscal Instrument No. of mining

countries (out of 25) No. of petroleum

countries (out of 67)

Signature bonus 1 16

Production bonus None 10

Royalties 25 50

Resource rent taxes 5 9

Additional income taxes 4 3

Production sharing None 34

State participation 5 27

Social investments/infrastructure 1 6

So what would be an attractive fiscal framework?

Country circumstances require tailored advice, but generally within a framework that combines:

• A royalty on gross revenue

• A tax targeted explicitly on rents (and thus on the achieved results of extraction)

• Together with normal corporate income tax

• Bonus-bidding may have a role in mature or promising environments

FISCAL ANALYSIS OF RESOURCE INDUSTRIES (FARI) METHODOLOGY

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FARI Main Uses

1. Fiscal regime design and evaluation (our focus today) • Can be used to evaluate fiscal terms, assess bids in a

competing round, or perform sensitivity analysis 2. Revenue forecasting

• Composition and timing of expected revenue streams • Revenue management and calibration of fiscal rules • Integration of forecasts into macro framework

3. Revenue administration • Comparing actual, realized revenues with model

results (tax gap analysis, risk assessment)

Design Principles

• Excel based, discounted cash flow model structure • Simple framework that can be easily picked up by

analysts with limited experience on natural resource taxation

• Flexible approach to handle diversity in fiscal regimes

• Standard suite of analytical routines and outputs

Project-specific modeling approach

• The interaction of different fiscal instruments is complex and its effects varies from project to project

– Limited insight from headline tax rates and fiscal parameters

– For example, appropriate treatment of depreciation, loss carry forwards, and ring-fencing is important

• Thus, modeling should be project specific:

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Inputs

• Project data, economic assumptions and fiscal regime parameters

Calculations

• Project cash flows and fiscal calculations

Output

• Standardized fiscal outputs and economic indicators

Model Structure

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Project1

Project Cashflow

Project2

Project3

Project4

Project5

Country A original

• Escalated costs • Commodity prices • Revenues

• Standardized project examples

Country A alternative

Comparator regime 1

Project n

Comparator regime 2

Comparator regime 3

Comparator regime 4

Comparator regime n

Regime Results

• Standard templates, tailored to each regime

Fiscal regimes Project Examples

• Consolidates standard set of outputs from each regime

AETR

METR

Stochastic Analysis

Sensitivity analysis

Sectoral Analysis

Analysis

• Analysis and comparison between regimes

CONTROL • Select project • Select price • Economic assumptions

Indicators commonly used in FARI

Average Effective Tax Rate • Government revenues as a share of pre-tax net cash flow • Cumulative over project life at various discount rates

Marginal Effective Tax Rate • The tax wedge for a marginal project which just reaches the hurdle rate post-tax

Breakeven Price • Price required to achieve a minimum post-tax IRR required by the investor

Share of Total Benefits • Government revenues as a share of revenue minus operating cost (quasi-rents) • Cash flows available to meet investment, return on investment, and taxes

BRIEF OVERVIEW OF MINING FISCAL REGIMES IN SELECTED COUNTRIES

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Mix of established, small and potential gold producers with different regimes

• Established producers, such as Australia (Western Australia), Ghana, South Africa, and Canada (Ontario)

• And other small and potential producers such as Chile, Brazil, Mongolia, PNG, Liberia, and Zambia

• The fiscal regimes of these countries include a wide range of instruments, such a different type of royalties, CIT, additional profit taxes, and state participation.

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Royalties: different variations

• Most countries in the sample have fixed rate royalties levied on the value of production…

• However, Ontario levies its royalties on net profits with the rate varying on the location of the mine;

• PNG royalty base is the net-smelter return or the FOB export value; and

• South Africa’s royalty rates vary as a function of the ratio of EBIT to gross sales and whether the mineral has been refined.

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CIT also follows different forms

• Most countries have a fixed rate CIT (some are a combination of national and state/provincial CITs) ranging from 24% to 42%...

• Chile offers a higher rate for projects with fiscal stability contracts;

• PNG levies a higher rate on non-resident companies;

• South Africa and Zambia a have variable CIT rate, which depends on the ratio of taxable income to gross income

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Additional profit taxes: two cases

• Chile applies a specific mining tax (SMT) to companies with sales over 12,000 metric tones per year

• The tax base is taxable mining income, the effective rates range from 0.04% and 14%, and the tax is deductible against CIT

• Liberia imposes a resource rent tax (RRT) that is triggered when the pre-tax IRR of a project reaches 22.5%

• The tax base is the project cash flows, and the rate is 20%, and the RRT is deductible against CIT

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State participation: three variants

• Ghana imposes a 10% free state equity interest on mining projects, which effectively works as a dividend withholding tax (subject to dividend distribution policies)

• Mongolia imposes a 34% state equity carried through exploration and development, which is repayable from the start of production with interest

• PNG state participation option ranges between 0 to 30%, and it is only carried during exploration, which means the state has a working (fully paid) interest from development

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ILLUSTRATION OF FARI MODELING RESULTS

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Gold mine: project economics

• An illustrative small/medium gold mine is used for illustration purposes

• The mine produces 2 million ounces of gold over 12 years, reaching a peak production rate of 200,000 ounces in years 3-11.

• With a unit cost of $516/ounce and using the latest WEO price projections, the mine is relatively profitable with a pre-tax IRR of 27.5%

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Government take (AETR) [Correct spelling of “marginal”; what is “invariability regime” for Chile?]

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- 20% 40% 60% 80% 100% 120%

Mongolia; Current regime (34% State Equity)

PNG ; General regime, 30% state participation

Ghana; Current Regime

Zambia; Current Regime

Chile; Tax invariability Regime

Liberia; Revenue Code 2011 (Current)

Brazil; Current Regime

South Africa ; Current regime (gold)

Australia; Western Australia

Canada; Ontario

AETR for Selected Regimes

AETR NPV0

AETR NPV10

Project: GoldMine

Size: 2.0 MM ounces

Unit costs: $516/ounce

Gold price: WEO

IRR pre tax: 27.5%

Marginal

Not viable

Breakeven price and METR

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936

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850 846 838 833817

802791

700

750

800

850

900

950

0%

10%

20%

30%

40%

50%

$/ou

nce

MET

R

Hurdle Price and METR

METR (left axis) METR (left axis) Gold price required for hurdle rate of 12.5 % (right axis)

Progressivity: government share of total benefits

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720 820 920 1,020 1,120 1,220 1,320 1,420 1,520 1,620 1,720

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

13% 16% 19% 22% 25% 28% 31% 34% 37% 40% 43%

Gold price ($/ounce)

Go

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PV

10

Pre Tax IRR

Australia; Western Australia

Brazil; Current Regime

Canada; Ontario

Chile; Tax invariability Regime

Ghana; Current Regime

Liberia; Revenue Code 2011(Current)

Mongolia; Current regime (34%State Equity)

PNG ; General regime, 30% stateparticipation

South Africa ; Current regime(gold)

Zambia; Current Regime

IMF ADVICE IN KENYA: CASE STUDY

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Kenya’s petroleum fiscal regime reform

• Recent discoveries attracted investor interest • However, fiscal regime dated from the 1980’s • Kenya asked FAD for technical assistance on tax policy

for extractive industries • FAD fielded various missions between 2013 and 2016 to

assist in reforming the fiscal regime for petroleum: – New model PSC, with improved petroleum sharing mechanism – Revised income tax legislation for the sector – Improved capacity building across government ministries on

fiscal regime design and fiscal modeling for the sector

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For More Information… Please visit: http://www.imf.org/external/np/fad/fari/

QUESTIONS?

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