Taxation of Minerals, Oil and Gas

1. Taxation of Minerals, Oil and Gas Taxation Options

2. Taxation Options A very wide variety of tax instruments and combinations of instruments. • Taxes on Income or Profit • Taxes on Output • Quasi taxes

3. But stepping back to company decision making Tax impact on companies willingness to invest via impact on: • P/I ratios (Post Tax Profit/Pre Tax Investment) • Internal Rate of Return (IRR) • Materiality Which can be modelled and estimated under different tax assumptions

4. Company Decision Making Project Economics Financial and decision making criteria easy to model but final decision has to take into account: • Technical risks and potential cost over-runs e.g. HPHT where technical problems can be very costly • Political Risk – e.g. Venezuela and the risk of expropriation or BP’s Russian experiences

5. An Uncertain world

6. Huge Variation in outcomes and opportunities

7. Variation in project profitability – an illustration of economic constraints

8. Taxes on Income • Corporate Income Tax • Very widely used • In some cases, adapted to include stepped rates (Progressive profit taxes) • Or a higher flat rate for petroleum companies • May be on measure of profit before or after accumulated depreciation • Ability to use existing legislation and framework • Trend towards lower general CIT rates • May be imposed on a project basis rather than on the entity

9. CT base: Key Decisions System requires rules on: • Income streaming? (in a schedular system like UK) • Loss carry forward/carry back • Tax deductibility • Group relief • Rollover relief for capital gains and indexing

10. Taxes on Income 2. Resource Revenue Tax • Often a supplemental tax on top of general corporate income tax • May be very closely aligned with economic rent [Example – Tanzania experience]

11. Example - Zambia’s windfall tax • Windfall tax – introduced 2008 • Withdrawn 2009 • 25% windfall tax and 15% profit tax on income over 8%

12. R-Factor Tax • Links taxation to the investment pay-back ratio • i.e. Ratio of cumulative receipts over cumulative cost • Tax only when R-Factor exceeds 1. • Used by e.g. South Africa, Columbia, Russia (Sakhalin II), Tunisia, India

13. Cash-Flow Variant • Cash-flow based tax linked to the real rate of return • Based on current value of cash flows • Applies after the target rate of return has been achieved • Target rate of return should be equal the supply price of capital, taking into account risk premiums

14. Withholding Taxes 1 . Withholding tax on dividends • Encourages retention of capital 2 . Withholding taxes on interest • Encourages retention of capital 3. Withholding taxes on consultancy fees and services • Encourages use of local services • Can offset transfer pricing • May be DTA issues

15. Royalties • Royalties on production volume • Royalties on production value (may be progressive) • Valuation issues and transfer pricing • But very widely used 3. Royalties based on profit

16. Profit royalties • Preferred by companies • More risk to government • Delay to tax receipts • Responsive to pricing/profit fluctuations • More complex administration • More scope for disagreement • May be progressive (South Africa profit royalties - 0.5% to 5% - deferred until 2010)

17. Customs Duties Typically: • very substantial level of equipment imports in early phase • Giving rise to significant early-year liability to duties Many countries exempt specific mining equipment from import duties.

18. VAT Frequently: • Exports are zero-rated • Giving rise to significant repayments re VAT paid on imports • .. So some countries will exempt industry-specific imported capital goods and some imported raw materials from VAT

19. Quasi-Tax Instruments • Prospecting fee • Rental fee • Signature or discovery fees (oil) • Production bonus • Land-use fee • Production sharing ( mostly used in oil, where may be more domestic demand than for other minerals)

20. Quasi-tax instruments 7. Service contracts (mostly used for oil) 8. Equity sharing – for example: • paid-up equity on commercial terms • paid-up equity on preferential terms

21. UK regime – why not use a mix? The fiscal regime which applies to exploration for and extraction of oil and gas from the UK and the UK Continental Shelf (UKCS) consists of three elements: • "Ring Fence" Corporation Tax (CT) • Supplementary Charge ( a stepped rate) • Petroleum Revenue Tax (PRT) – a rent resource tax that applies to fields developed before 1993 • But mix like this not ideal if you can avoid it! (And we used to have royalties.)

22. Mixed Regimes • Complexity • Distorts investment decisions on incremental investment decisions • Unwinding can creates winners and losers arbitrarily • Adding incentives can create further undesirable distortions

23. Myths – Government needs to own the oil • Popular debate often assumes that allowing IOCs to operate results in loss of control, e.g. in Iraq over new oil law • Little evidence that this is true in practice as UK shows that regulation of production in terms of e.g. field development plan sign off can be dealt with separately from taxation.