Petroleum & Mineral Taxation

Front 1

Why Tax Extractive Industries?

Back 1

-compensate state for taking its minerals
-price of exploiting public asset
-redistribute benefits
-deal w/ social/econ/political impact of resource exploitation
-large profits

Front 2

Corp vs. Govt Interests

Back 2

Corp
-profit
-control
-fiscal policy preferences (neutrality, stability, etc.)

Govt
-maximize revenue over long-term
-predictable tax revenue
-efficient extraction
-easy admin
-local benefits
-tech transfer
-increase tax revenue
-develop related industries
-politics
-Govt Discount rate lower b/c can wait longer for revenue

Front 3

What makes Mineral Industry special?

Back 3

-investment size
-time
-location
-risk
-int'l markets
-employment
-non-renewable resources
-size of GDP
-Resources belong to state, tax for exploiting public asset and encourage local benefits

Front 4

Economic Rent, Rent

Back 4

-Economic Rent: earned income higher than normal.
-Rent: total revenue from life of project, minus explor/develop/operating costs and min. rate of return for company

-Rent Size: depends on size/grade/ease of deposit, location, mgmt efficiency, size of local market, availability of skills/tech, investor's discount rate.

-Mineral Rent's unique aspects: smal # of mines operational ag given time, nearly all mines yield economic rent.

Front 5

Resource Rent

Back 5

-Resource Rent: difference b/w production cost for deposit and production cost for marginal deposit. Nature's gift means increased value.

Types of RR:
-Ricardian R: "pure rent" from "fertile land"
-Scarcity R/Hotelling R & User Costs: resources are scare- and producing incurs an opportunity cost today rather than in future.

Front 6

Tax Types: 2 Views

Back 6

1) Economist View: compulsory levy raised by govt for which nothing received in return.
a) Direct: targeted at individuals who're intended to bear it. Can discriminate to certain degree b/w individual types (income).
b) Indirect: not targed at individuals; indiscriminately collected thru businesses involved in production & distribution (VAT).

2) Alternative View: taxes are any obligation imposed by govt having a cost.
a) Direct: layperson's view of taxes
b) Indirect: don't look like a tax, but same financial impact (local equity participation req, foreign exchange reg).

Front 7

Tax Instruments (PELVIC WILS)

Back 7

-Payroll tax: on company's total payroll expenses
-Env Taxes: pollution activities, energy consumption
-Land Rents: any industry occupying land
-VAT/Sales tax: levied on sale of minerals
-Import/Export duties: levied on equip imported for resource exploitation and mineral products exported (especially unprocessed)
Capital Tax: value of company's assets

-Withholding tax: on remittances paid to shareholders or corp. headquarters
-Income tax: directed at profit
-Local taxes
-Stamp duty: certain business transactions

Front 8

5 Specialty Taxes

Back 8

-Specialty: related to petro/mineral industries

1) Royalty: levied by govt on resource exploitation, based on quantity/value of mineral produced.
2) Bonus Payments: fixed/negotiable fees paid at predetermined stages of explor/prod process
3) Bid Auctions: highest bidder gains access to explor/prod rights. Purest is sealed bids
4) Profit-Related Taxes (in addition to Income tax): surtax, RR tax, Brown tax
5) Country-specific taxes (UK's petroleum revenue tax).

Front 9

Deduction

Back 9

-Deduction: direct reduction of tax base.

-Cost deductions:
1) Expensed Costs: deducted from tax base in yr cost incurred (operating cost, royalty, interest paymt, overhead)
2) Capitalized Costs: deducted later than incurred. 2 types:
a) Depreciation: tangible asset. 5 methods:
i) straight-line (equal installments over defined time pd),
ii) Declining balance: % rate of depreciation derived from total dep. pd (ex: 4 yrs = 25%)
iii) Double Declining balance: same, except dep. rate double.
iv) Sum of yr's digits: fraction of yr/total yrs x asset's original $ value.
v) Unit-of-Production: dep. amt is ratio of annual prod : deposit's remaining reserve.
b) Amortization: intangible costs (feasibility study)

Front 10

Loss Carry Fwd/Back

Back 10

-Losses incurred 1 yr carried fwd/back to profitable yr.

Front 11

Cost Recovery

Back 11

-PSCs it's often "cost oil". 2 parts:
1) Cost
a) Recoverable: expl/dev/operating costs
b) Possibly recoverable: overhead, field abandonmt
c) NEVER: bonus paymt, royalty

2) Rate
a) Ceiling: max. proportion of annual prod.
b) Annual produciton limits (40-60%)
c) Depreciation schedules

Front 12

Ring Fence

Back 12

RF: phys area, range of activities, or both, from which costs may be recovered from revenues for tax purposes

Front 13

Credits

Back 13

TC: alowance deducted directly from amt of tax payable, rather than tax base (investors likey).

2 types:
1) Investmt credit: against specific tax for specific type of investmt
2) Reinvestmt credit: same, BUT targeted at reinvestment of country where it already has revenue.

Front 14

Uplift

Back 14

Uplift: like a tax credit b/c allows value of capital investmt to be enhanced by fixed % for tax purposes, often exploration 20-50%.

Front 15

Tax Holiday

Back 15

TH: periods in project's early stages when defined tax not payable.

Front 16

Tax Abatement

Back 16

TA: mechanism for giving preferential treatment to particular sector of economy w/o changing general income tax. One level of govt can take it to allow for tax taken by other level of govt. 2 Choices:
1) Reduce % of tax base or tax rate?
2) Life of project or specific pd?
2)

Front 17

Flow-Through Shares

Back 17

-FTS: allow individual shareholders to benefit from company's tax allowances.
-Value of tax allowance passed thru to shareholders.

Front 18

Depletion Allowance!

Back 18

DA: paid to landowner based on gross revenue of property (~royalty), ONLY where resource owned by private individuals.
-Inefficient for encouraging exploration.

Front 19

Income Tax

Back 19

-IT: compulsory tax on realized net income.
-Key elements: base definition, rate.
-Special IT's include:
a) Sliding Scales: tax rate increases in discrete steps as tax base increases (more w/personal than CIT)
b) Surtax: % of existing tax payment.

Front 20

4 Qualities of Fiscal Regimes

Back 20

1) Efficiency
2) Equity
3) Neutrality (+progressive/regressive)
4) Stability

Front 21

Efficiency

Back 21

-Quality of fiscal regime
-Efficient tax: collects rev. for govt w/o sig. affecting behavior of pertinent econ. actors nor distorting econ. activity.
-Should restrict to econ. rent, unless want to influence activites
-Neither too high nor too low

Front 22

Equity

Back 22

-Quality of fiscal regime
-Equity: an aspect of Fairness.
-3 approaches:
a) Ability-to-pay: relates individual's tax amt to his income
b) Benefit-related: relates tax payable to scale of benefit received by individual (road tax)
c) *Utility Maximization: seeks max. utility; greatest satisfaction to greatest # parties. (50:50 to 90:10)

Front 23

Neutrality

Back 23

-Quality of fiscal regime
-Neutrality: neither deter investment otherwise made, nor encourage investment otherwise wouldn't be made
-Non-neutral fiscal regimes may support strategic objectives for economy, but will cost country in lost tax rev.

-Progressive: tax rate increases as size of tax base grows.
a) All neutral fiscal regimes are progressive. But not every progressive regime is neutral.
-Regressive

Front 24

Stability

Back 24

-Quality of Fiscal Regime
-Stability: likelihood that fiscal regime will remain unchanged, b/c investors want confidence long-term investment will yield expected rewards.
-Stabilization clauses in Ks.
-2 Factors of Stability:
a) Stability of Govt Policy: stabilization clauses restrain govt
b) Flexibility of Fiscal Regime: ability of tax regime to adapt to changed circum's. More neutral = more flexible b/c directed at ER.

-3 Examples of flexibility:
1) Revenue-related taxes: inflexible
2) Profit-related taxes: more flexible
3) NPV-related taxes: most flexible.

Front 25

Risk vs. Reward

Back 25

-greater the risk, the greater the reward req'd.
-Investor's Risk: fail to achieve min. IRR. They manage this risk using holding companies w/# of projects in different countries.
-Govt Risk: tax revenues small, later than expected. Govt manages risk by using Stabilization fund to cover fluctuating prices.

5 Ex: of Shifting Risk b/w Govt & Investor-
1) Signature bonuses: shift to investor
2) Tax relief for failed exploration: to govt
3) Small Ring Fence: to investor
4) RRT: to govt
5) Royalty: to investor

Front 26

Imposition & Admin. of Tax

Back 26

-Imposition: task of setting the variables (rates & allowances) for each tax instrument comprising the Regime.
-occurs when new Regime or parties want to change rates.

-Administration: task of assessing and collecting tax liabilities of individual investors.
-Need qualified specialists to be effective.

3 Categories of Regimes & Imposition/Admin qualities:
1) Difficult imp, Easy admin: PSC, Signature Bonus, Royalty
2) Easy imp, Difficult admin: IT, RRT
3) Easy imp, Easy admin: Bid Auction

Front 27

Federal Regimes & Resource Taxation

Back 27

1) Levels of fed. taxation: fed, state, municipal, land owner

2) Adv. vs. Disadv.
a) Adv: local govts have more power over revenue collection & expenditure
b) Disadv: excessive tax burden, directed at rev. not profits, excessive admin., loss of fed control

3) Fed Options for gaining control:
a) Withdraw/reduce local tax powers
b) Treat local taxes as deductible
c) Encourage profit-related taxes by local govt
d) Provide generous allowances

Front 28

Int'l Regime Comparison

Back 28

1) Qualitative:
a) Method & level of tax (elaborate: NPV, profit, rev.)
b) Ability to pre-det. tax liability
c) Stability & simplicity

2) Quantitative: 3 approaches
a) Stat. rates
b) Marginal rates (for add'l unit of prod.)
c) Avg effective rates over project's life

Front 29

Tax Treaties

Back 29

1) TT: Double taxation treaties to minimize double taxation (2 govts levy tax on same rev., profit, capital).

2) Goal: provide relief from DT, improve admin, fair division of rev., encourage investment, & discourage treaty shopping.

3) How:
a) Full/partial exemption in host/home state
b) Credit in home state for taxes abroad
c) TT trumps domestic law
d) Unilateral Relief when no TT (US)

4) Important Def's:
a) Residence req's
b) Source of income
c) Quantification of income for relief
d) Types of foreign tax creditable
e) Tax Sparing (b/w developed/ing countries so investors can take adv. of certain Allowances).

Front 30

Transfer Pricing

Back 30

-TP: corp moving tax base around world thru internal pricing mechanism to min. tax liability.

-Since TP often set at neither market nor arm-length price, 4 Methods:
a) Comparable Uncontrolled Price Method: if sale of comparable good can be identified where neither B nor S took part.
b) Resale Price Method: if B sells goods w/o add'l processing. (reduce TP by mark-up)
c) Cost-Plus Method: unfinished good/raw material that's exported. Mark-up is added to unit cost.
d) Split profits: split profits b/w 2 related entities or acrwoss whole of transnat'l corp.