Petroleum Tax Administration

Regional Petroleum Seminar

Libreville

April 28 to 30, 2008

Charles McPherson

IMF Fiscal Affairs Department

Outline of Presentation

Relevance Special features of the petroleum sector Tax design and tax administration Routine functions Non-routine functions Non-core activities Organisation

Outline of Presentation (cont’d)

Building capacity National Oil Companies Transparency Political economy considerations

Relevance of Petroleum Tax Administration

Transformation of oil wealth to development depends on:

• Sector management

• Tax design

• Tax administration

• Revenue management

• Expenditure management Tax administration is just one factor among several,

but it is significant… And a difficult challenge….

Significance:A Prussian Parable

One of the most delightful stories in the entire history of taxation came from Frederick's troubled times. During one of his cabinet meetings Frederick asked his finance minister why his treasury was so low when his subjects were paying so much tax. Where was all the money going? To explain the problem, the finance minister asked for a piece of ice. He handed it to the minister farthest from the king and told him to pass it to the next person, on up to the king. By the time the ice reached Frederick all he received was a wet hand. The lesson the finance minister taught the king ranks in wisdom with the parables of the Bible. Most taxes are consumed by the bureaucracies of the government. It is a wonder Frederick even received a wet hand.

Challenge:Tax Administration under

Ivan the Terrible

Special Features of the Petroleum Sector

Scale (tax revenues, macro impacts…) Complexity (operational, legal, contractual) Volatility (revenue, regime changes) Integrated value chain (fiscal reference

points) International industry (transfer prices,

withholding) Asymmetries (expertise)

Tax Design and Tax Administration

Sophistication vs. capacity Taxes on production vs. income taxes Production sharing vs. tax/royalty regimes

Routine Functions

Registering taxpayers Processing returns Assessing tax Collecting tax Accounting standards (IAS, GAAP) Currency of account

Procedural Steps

ProvisionalTax

Declaration

Oil Valuation

Payment ofTax

FinalDeclaration& Payment

TaxAudit

FixationCommission

RevisionCommission

Before tax year

During tax year

After tax year

AmendedProvisional

Declarations

Informational Requirements

Taxpayer requirements:• Clear, accessible legislation/regulations

• Explanatory materials/advice

Tax collector requirements:• Operational information

• Contractual agreements and JOAs

• Operator and JOA Audits

• Prices

• Costs

Problems Encountered in Routine Administration

Multiplicity of taxes Multiplicity of agencies Weak filing/payment procedures Poor accounting systems Weak or absent IT

THE IDEAL APPROACH…….

TAXES PAID

TAXES RECEIVED

TAX PAYERMIN.FIN. & TREASURY

A B

A=B=C

C

TAXES DUE

TAX PAYER

PETROLEUM REVENUE REPORTING

Reconciliation Issues

Off-sets/QFAs Direct payments to sub-national governments US dollar accounting vs. local currency Payment timing in context of depreciating

currency and inflation Cash vs. accrual accounting Inter-agency reconciliation

Non-routine Functions

Volume determination Price determination Cost determination Audits Appeals

Volume Determination

Metering Quality analysis Adjustments Monitoring

Price Determination

Market value as a goal…. Arms-length prices Reference prices Integrated operations Transfer prices In kind revenues

Cost Determination

Cost categories Cost control Ring fencing Finance costs Transfer prices Environmental and abandonment costs

Ring Fencing Separation of taxable projects for purpose of

calculation of tax liability Licence-by-licence or project-by-project Pros:

• Avoids deferral of revenue• Levels playing field for new entrants• Avoids administrative complexity where multiple tax

regimes Cons:

• Limits incentive to invest in new activities• Additional demands on cost control

Finance Costs

Project financed oil developments often highly leveraged (heavy use of debt)

Interest is typically deductible in determining taxable profits, but

Many countries have provisions to protect their tax base vs excessive interest payments

A typical rule might limit allowable debt/equity ratio to 3:1

Interest charged should be arms-length

Transfer Pricing

Investor allocation of revenues and costs across countries to lower taxable income

Legislation/regulations should provide for: • Adjustments to ensure arms-length pricing

• Adoption of OECD Guidelines

• Disclosure of related party transactions

• Documentation on determination of transfer prices Cooperation with tax authorities in investor

home countries can help

Illustrative Transfer Pricing Mechanisms

Mechanisms used to lower revenue:• Sales below market to affiliates

• Price hedging Mechanisms used to increase deductions:

• Debt finance at above market rates

• Excessive management, HQ and consultancy fees

• Provision of goods at above market costs

Environmental and Field Abandonment Costs

Legislation or concessions usually contain requirements with regard to environmental protection and field abandonment

Funds may be placed in an escrow account for this purpose with tax deductions allowed

Alternatively, current expenditures may be deducted currently and deductions may be allowed currently for future expenditures, provided security is put in place to ensure those expenditures

Audits

Audit types (physical, cost, tax) Audit choices (full vs. selective etc.) In-house or out-sourced? Role of investor audits National oil company audits

Appeals

Disputes are inevitable… Informal vs. formal resolution Tax tribunals vs. courts In-house legal skills vs. out-sourced

Complementary Activities:Tax Policy and Forecasting

Tax policy capacity is a critical complement to tax administration

Tax modeling can be used for:• Longer term forecasting

• Improved planning for different scenarios

• Cross-check on audit results

• Evaluation of agreements

Organisation

Governance/accountability Separate unit? Where? Centralised vs. decentralised Inter-agency coordination

Analyst Analyst Analyst Analyst

Possible Institutional Structure

Monitoring filing and payments

Valuation & tax audits

Dispute resolution

Taxpayer advice &

policy

External Legal ServicesExternal Tax Audit

Consultants

Director NTD

Head NRT

Building Capacity

Staffing/skills mix Training Compensation Resources/facilities/IT Consultancies Funding

National Oil Companies

Fiscal treatment Fiscal administration roles Cost control Marketing of government production Quasi-fiscal activities (QFAs)

Transparency

Explicit legal basis Limits on discretion Easily understandable and accessed laws Tax manuals/taxpayer advice Public reporting Ethical code EITI and IMF Guide on Resource Revenue

Transparency

Political Economy

Long-standing recommendations Powerful entrenched interests Practice vs. policy What is the appropriate response?

Petroleum Tax Administration

Thank you.

Questions/comments?