Tax in the Extractives: World Bank Group Perspective

Rich Stern

Lead Tax Officer World Bank Group

Mexico City, Mexico 4 July, 2014

Revenues from Natural resources

Source: IMF Fiscal Affairs Department

FDI in mining is not correlated to tax rates

ARG

AUS

AUTBELBRA

CAN

CHNCRI

CZE DNKECU

FIN FRADEUGRC

HKG IND

IDN

IRL ITA JPNKOR

MYS

MEX

NLD

NGANOR

PER

PHLPOL RUS

ZAFESP

SWECHETHAGBR

VEN

01

23

4

US m

inin

g FD

I as

a %

of G

DP

0 10 20 30 40METR 2012

US mining FDI outflow to country X as a % of country X's GDP Fitted values

Introduction: WBG has been working in the extractives in a piecemeal way for years

♦ Bank’s Oil, Gas, and Mining Unit (SEGOM) develops/ supports government policy frameworks-also home to EITI

♦ WBI has been instrumental in transparency issues—especially contracting as well as knowledge sharing and data collection

♦ IFC Oil, Gas, and Mining Department –taking direct and indirect investment positions in extractives investments

♦ IFC Advisory Services has provided TA on facilitating linkages, public private partnerships, and leveraging FDI spillovers

♦ Global Business Taxation Team has provided TA targeted at reforming and implementing tax regimes conducive to investment while protecting the revenue base

The international agenda has generated a rethinking of a coherent extractives initiative, launched Oct. 2013

• G8 and G20 focus on both domestic resource mobilization and tax transparency has led to focus on extractives (St. Petersburg Summit, 2013)

• EITI focus on setting standards for reporting and transparency

• Base erosion and profit shifting action plan identifies harmful tax competition and tax avoidance , transfer pricing, investment financing

• as key issues • WBG internal focus on transparency in contracting,

responsible investment, and pivotal role of tax as key component

Knitting together various pieces of WBG work into a global initiative

Extractives Industry

DVLP

Direct and indirect

investment (IFC)

Transparency in contracts

Extractives Policy TA,

development and linkages Transparency

and EITI Initiative

Business Taxation Technical

Assistance

Drilling down on what we do in tax in the extractives: Individual workstreams

♦ Tax incentives (all), instruments, provision, administration, and monitoring ♦ VAT instrument and administration (relates incentives, refunds as well as local content and sourcing) ♦ Transfer pricing and international taxation issues, relating both to

related-party transactions directly related to the investment as well as use of investment as a profit shifting platform.

♦ Working through public-private dialogue groups to gain consensus for reforms

What instruments do we have at hand?

Revenue rise due to increased investment

Social benefits from increased investment

Indirect cost of incentives

Lost revenue from investments that would have been made anyway

> + +

Benefits

9

Social Benefits include cleaner environment,

better skills, better health, etc.

Costs

1. Incentives: costs and benefits

AUS

AUT

BEL

BWA

BGR

CANCHL

DNK

FJI

FINFRA

GEO

DEU

HKG HUN

ISL

IRL

JAM

JPNKOR

LVA

MYSMUS

MEX

NLD

NZLNOR

PER

PRT

ROM

SGP

SVK

ZAFESP

SWE

CHE

THATUR

GBR

USA ARGBGDBOL

BRA

TCD

CHN

CRI

HRV

CZE

ECU ETH

GHA

GRCINDIDN

IRNITA

KAZJOR

KEN

LSO

MDG

MARNGA PAKPOL

RUSRWA

SRBSLE

VNM

TUNUGA

UKREGY

TZA

UZB

ZMB

010

2030

FDI a

s %

of G

DP

-20 0 20 40 60METR

High IC countries Low IC CountriesTrend High IC countries Trend Low IC Countries

Fiscal Policy Effectiveness and the Investment Climate

Almost no impact of lowering Effective Tax Rates on FDI in low IC countries

10 Source: James and Van Parys, 2009

Incentives: what and where

Most incentives are granted to offset or mitigate high, fixed start up costs

♦ Most typical tax CIT-based (holidays, deferments, reductions) designed to mitigate exploration cost, but timing is off use possibly as a vehicle in related party transactions

♦ VAT/import duty exemptions are common, especially but not exclusively in mining Used in combination with import duty exemptions, but can have

impact on local content/domestic sourcing Sometimes ringfenced, so VAT application depends on the

transaction(hard to monitor, promotes misclassification) and refund issue comes into play

♦ Other typical tax incentives: capital allowances and deductions, accelerated depreciation

Once you’ve given away the store, is there any good practice left?

♦ TRANSPARENCY IN ALL INCENTIVES—both in terms of what they are, how they are applied, and who gets them.

♦ Limit CIT holidays. As a second best option, don’t extend tax holidays to investments in extractive-related services.

♦ To this end, think about applying transfer pricing and other international tax principles to the indirect investments.

2. VAT: affects direct investment and spillovers

Issues ♦ VAT is a barrier to investors (policy

breaks in the chain, VAT refunds issues, compliance issues)

♦ VAT efficiency and administration ♦ Link VAT to MSME where needed

(can be in MSME work) ♦ Perception of VAT as gross, not net

(interest free loans to government) ♦ VAT refund request trigger audits ♦ VAT refunds delayed if processed at

all ♦ Cash flow (gov. and private sector)

Solutions ♦ Analysis of VAT value chain-

diagnostic on breaks in the chain

♦ Diagnostic on refund process ♦ Collect good practice policy

and admin systems ♦ Develop sector specific

knowledge applied to VAT ♦ Develop km RBA component

for ex-post refund audit ♦ Develop simple estimator for

refunds levels ♦ Develop menu of integrated

solutions with treasury function

2. VAT Selection of good practice lessons learned so far

♦ Countries which employ risk-based approach to VAT administration and especially VAT refund adjudication have higher and faster rates of refunds, and higher net revenues (Baltics, South Africa)

♦ Relatedly these countries which use “risk channeling” (green channel, red channel) are the most effective

♦ VAT refund timing and level is an indicator for how effective VAT system is (Europe, LAC)

♦ Most advanced VAT refund techniques do not involve cash in-cash out, they involve either virtual accounts or accounting techniques (Lithuania)

♦ Countries with VAT refund forecasting tools have the most effective VAT refund systems (Baltics, Europe)

♦ Dedicated “VAT Refunds” account at the Central Bank, populated with a share of previous month VAT revenue

Traditional taxonomy of approaches + offset options

Source: Harrison and Krilove (IMF) 2007

Selected newer approaches for VAT refunds (from country practice study)

♦ Cash and Virtual accounts booked at time of import and export, with time determined by economic activity (Bulgaria)

♦ Non-cash payment at import, compliance accounting exercise as a part of monthly reporting form, yearly reckoning (Lithuania)

♦ Refunds credited to past and future (expected) tax liabilities—any national level tax (being considered by Albania), requires more IT sophistication.

TRANSFER PRICING

Important part of DOMESTIC RESOURCE

MOBILIZATION

TP for developing countries in G20’s

PLAN

Increase in FDI flows, trade and the

importance of MNEs CIVIL SOCIETY advocating for more

transfer pricing awareness/

enforcement for developing countries

Multinational investors are seeking more CERTAINTY IN THE INVESTMENT

CLIMATE

3. Transfer pricing

♦ Public sector priorities: Protect the income tax base

Provide attractive investment

climate

Neutral treatment of domestic

and multinational businesses

Competition among Tax

Authorities to secure a “fair”

share of MNE’s taxable profit –

double taxation

♦ Private sector priorities: Minimize global tax, starting

with source country tax

Tax risk => shareholder

pressure

Adjustments, Double taxation,

penalties (and interest)

Managing compliance costs

(legislation is growing across

jurisdictions)

Reputational risks

18

Transfer pricing in developing countries

What is the global trend in transfer pricing:

Specific transfer pricing legislation is being introduced Arm’s length principle – comparability and OECD methods

Some deviations observed:

Deviation from market price concept (10/20% etc)

Transactional profit methods not specified

Extension of law to transactions with “tax havens”

New disclosure requirements

Targeted capacity building within tax administrations

APA programs are being considered / developed

Formalization of the competent authority function (MAP)

SAFE HARBORS!

♦ Capital flight and illicit flows ♦ Inter-relationship with customs valuation ♦ Tool to suppress wage claims (to demonstrate subsidiary

is not profitable) ♦ Joint ventures - Artificially decreasing profits to reduce

amount of JV profits to be shared ♦ Circumvent foreign exchange controls ♦ Inter-relationship with royalty tax

Importance of TP goes beyond the transaction

Summary: Technical assistance offerings—what we do

Workstream ♦ Tax Administration

Simplification

♦ Sub-national Taxes & Regulations

♦ Small Business Tax Reform

♦ Tax Legal & Appeals Reform

♦ Risk-based Audit System

♦ Tax Incentives Reform

♦ International Taxation

Issues addressed Business tax administration is

burdensome (CIT, VAT) Misuse of regulatory fees as

revenue tools (esp. sub-national)

Small business facing high compliance costs

Overly complex, cluttered tax laws & appeals system

Excessive and discretionary tax audits

Tax competition has led to sub-optimal tax incentive structure

Distinguishing between tax

evasion and tax avoidance

Tools

METR Analysis

Tax Admin Process Mapping

Standard Cost Model (SCM)

Compliance Costs Surveys

Inventory of Fees & Charges

Incentives Review

Profit Margin Analysis

TP Needs Assessment

Yemen

The Business Tax Program

Central African Republic

Burkina Faso Guinea Bissau

Guinea Benin

Cameroon

Central Asia Region - Kyrgyz Republic, Tajikistan, Uzbekistan

Pakistan India, Bangladesh Nepal

Lao PDR Vietnam Thailand

SEE Region –Albania, Bosnia & Herzegovina, Serbia

East African Community - Burundi, Kenya, Rwanda, Tanzania, Uganda

Liberia Sierra Leone Cote d’Ivoire

Ghana Indonesia

Papua New Guinea Solomon Islands

Ethiopia

Armenia Georgia

Azerbaijan

Honduras Costa Rica El Salvador

Colombia

Peru

Panama

Caribbean Region (OECS)