The United Nations has released the Extractive Industries Handbook at the 16th Session of the UN Committee of Experts held in New York from 14 to 17 May 2018. The handbook focuses on specific areas on interest for developing countries in taxing companies in the extractive industries. Developing countries need to combine an effective tax system with the need to attract foreign direct investment.
The extractive industries produce minerals including crude oil, natural gas, traditional mining products and rare earth elements. Although these sectors differ from one another in the nature of the exploration risks, environmental concerns and commercial structure they also share some similar features that affect the way the industry should be taxed.
Companies in the extractive industries face a high level of uncertainty and risk when commencing a project. The discovery of minerals does not always lead to actual extraction in practice because the cost of extraction may be too high or there may be other environmental reasons. The prices of the minerals are volatile and the profitability over the course of a long project may be affected by unforeseen fluctuations. The demand for minerals fluctuates according to the state of the world economy and other developments such as the development of renewable energy sources and increasing legislation relating to climate change.
As specialist technology and expertise is required to extract resources projects in the extractive industries are characterized by high up-front expenditure and often a long period before production begins and revenue begins to flow. This means that companies need certainty including a stable tax regime.
There are particular problems for developing countries whose tax administrations face enormous challenges when dealing with private companies from the extractive industries or joint ventures. In developing countries the natural resources are often extracted by foreign firms owing to scarcity of local capital and these countries need to attract foreign direct investment. The private companies in the extractive industry are often better informed about the industry than the developing country governments and they can call on specialist advice in dealing with taxation issues.
The opening chapters of the handbook deal with tax treaty issues and with the concept of permanent establishment as it relates to the extractive industry. Another chapter deals with indirect transfers of assets. An indirect transfer takes place when instead of directly transferring an asset such as a mine the owner of an entity holding the asset may transfer its interest, such as shares, in the entity. The chapter on indirect transfers looks at whether and how a capital gains tax could be implemented and how indirect transfers are included in the capital gains tax regime.
The chapter on transfer pricing contains several examples of transfer pricing issues that arise in the extractive industries. The chapter looks at issues relating to the major stages in the extractive industries value chain and considers methods and approaches that could be used to address the particular issues identified.
Decommissioning extractive facilities to ensure that damage to the environment and effects on the population are limited is also addressed in the handbook. Adequate financial resources must be available when the facilities are closed. The chapter of the handbook on decommissioning stresses the need to consider the situation at the outset of projects and when designing fiscal rules for the extractive industries in developing countries.
The question of how countries attract foreign direct investment while balancing their economic, environmental, and social needs is a major challenge. This is discussed in the chapter on negotiation of a framework for development between an investor or investors and the government on natural resources. The chapter looks at issues in connection with the negotiation of such contracts, and the options for renegotiation as circumstances change.
The chapter dealing with the government’s fiscal take looks at the types of payment and other compensation that governments can receive from the development of natural resources, their response to differing economic circumstances and the implications of these for investors and interaction with other statutory tax rules. Another chapter considers value added tax including timing and refund issues.