Natural resource tax policyALTax
Natural resource fiscal regimes often present special legal administration problems. Converting natural resource wealth into sustained economic development requires: – Good management to ensure efficient and effective exploitation; – Good tax design to ensure appropriate government revenue and adequate incentives for investors; – Good revenue administration to ensure that revenue is collected in practice; and – Good public expenditure management to ensure that volatile and temporary natural resource revenue translates to permanent benefits for the nation and to manage the risk resource wealth poses to the wider economy.
Contract-based economic models are an important tool for natural resource tax policy, forecasting, and administration. An economic model is essentially a spreadsheet incorporating rules for calculating government natural resource revenues for a contract area for the full duration of a project. Models can be varied to include different tax, depreciation, and cost recovery rates, and so on.
Various projections of prices, costs, and production levels can be fed into the model and their impact on government take, investor return, progressivity, and timing of revenue can be measured. Governments in developing economies often lack the required modeling skills, but tax policy experts routinely construct such models for the evaluation of natural resource fiscal regimes, and expert technical assistance in developing and maintaining them is therefore available from various sources.
Contract models should be used as follows:
1. Natural resource tax policy development and contract negotiation. Governments can use models to experiment with various policy options and measure their impact. They can use them to assess the impact of modification of fiscal terms proposed in contract negotiations in a range of alternative price, cost, and production level scenarios. Companies generally use economic models to assess natural resource tax regimes and for contract negotiation, and governments are at a serious disadvantage if they do not have the same tools at their disposal.
2. Natural resource revenue forecasting and expenditure management. Projections of costs, prices, and production levels for the medium term and for the full life cycle of the project can and should be obtained regularly from natural resource companies, supplemented with figures from the government’s own sources. Responsibility for collection of the data, whether by the finance or natural resource ministry or partly by each, and for sharing it with other departments, must be clearly defined.
It may be necessary to impose a legal requirement on natural resource companies to provide the necessary data (production profile, exploration expenditure, capital by same categories as depreciation, operating costs, closure and rehabilitation costs, and price assumptions, especially for production sold through contracts) but it is generally in their interest to provide it because revenue predictability is likely to strengthen public trust.
These projections may be subject to some uncertainty, particularly over the long term. Often models are slightly simplified for example, they may assume that projected commercial capital and operating costs will be categorized in the same way for tax purposes, which may not be true, or they may not reflect some taxes, such as labor and some indirect taxes. Even so, model-produced forecasts are a far better basis for forecasting and planning than mere guesswork.
Alternative assumptions on prices and costs can be fed into the model to produce a range of possible outcomes around a central budget forecast, allowing planning for different contingencies. Assumptions should be regularly updated, at least quarterly. Publication of model-produced natural resource revenue forecasts can help manage public expectations, which otherwise are often unrealistic. Revenue projections for the long run are also essential in order to design fiscal rules for the management of natural resource wealth in countries that expect large windfalls from the natural resource sector.
3. Explaining actual natural resource revenue outturns.
Actual figures of costs, prices, and production levels reported by companies for tax purposes can be fed into the model, and the revenues projected by the model from those figures compared with actual revenues. As long as actual revenues are in line with the model projections (adjusted to reflect any simplified assumptions) this should provide reassurance to the government and the public that, at least if the reported figures are correct, actual revenues are in line with underlying policy intentions. The model should also allow the reasons for differences between forecasts and actual outturns to be identified and explained.
This should increase transparency and public confidence in the regime’s integrity. Tax authorities should provide explanations if actual revenues do not match model projections. This of course assumes departmental accounting systems that are adequate for this purpose, which may not always be true. Discrepancies (other than those from departmental accounting errors) may arise from arrears of unpaid taxes or erroneous calculations in company self-assessments (in which case confirmation that appropriate audit adjustments have been made will also be required).
4. Audit risk assessment. If the tax authority has information technology (IT) systems for electronic filing and tax calculation and database interrogation, economic models may add little (they may in effect already be built into its IT system). But, if not, comparison of model projections and actual revenues may identify errors that might not otherwise be picked up. For example, calculation errors or inconsistencies in figures assessed for different tax purposes or incorrect allocation of contract costs to individual companies. Differences between forecast natural resource revenues and outturns may also highlight unexpected cost increases or price declines that merit further investigation by tax auditors.
Because the main role of economic models is to support policy development and economic forecasting and planning, initial responsibility for developing and maintaining them and disseminating their results should rest with the finance ministry. This assumes that the finance ministry is responsible for natural resource fiscal policy in practice, the natural resource ministry or even a natural resource company may have primary responsibility for contract negotiation.
Tax departments should, however, be responsible for entering actual return data into the model to allow comparison and reconciliation of projected and actual revenues and, where appropriate, use in risk assessment. Moreover, it is generally recommended that economic models be regularly reviewed and maintained by an interagency group composed of staff from the key ministries involved in natural resource issues and the tax administration.