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Part C: Fiscal Terms - 36. Fiscal Terms - 36.3 Taxes | 36.3(g). Capital Gains Tax

Capital gains tax is a tax on the gain or profit made on the sale of a non-inventory asset. In the extractive sector, it is a tax on the gain made on the transfer of a mining license or interest in a mining license.

Countries approach natural resource rights transfers in various ways. A minority of countries choose not to tax the capital gains from such transfers at all (e.g. Norway), on the rationale that such transfers do not affect overall tax revenues to the state from the project. In such cases, the seller does not pay a capital gains tax, but the buyer is also not allowed to deduct the cost of the asset from future taxable income. Most countries tax the capital gain made by the transferor and allow the transferee to deduct the cost of the asset from taxable income by depreciation. Others both impose a capital gains tax and disallow corresponding depreciation of the costs, which has a strong negative impact on investors’ returns and can be seen as deterring investments.

Capital gains taxes are a sensitive issue and there are arguments both for and against imposition of such taxes.

On the one hand, transfers in mining licenses can involve large sums of money and the country may be seen to be missing out on this boon to the seller of the license if it is not taxed, especially if it is believed that the government got a bad deal in the original terms agreed with the seller. In reality, if a corresponding tax deduction is allowed from the buyer’s taxable income, the overall tax to the government from the project remains the same. However, imposing a capital gains tax allows the government to capture a share of the overall taxes earlier, which is advantageous to the government given the time value of money.

On the other hand, capital gains taxes can be difficult to administer and a country may seek to encourage transfers of licenses to investors best able to develop them.

If a government chooses to impose a capital gains tax, it should consider:

  • Treatment of indirect transfers and farm-outs
  • The impact of tax treaties
  • Enforcement of capital gains tax provisions against non-residents

If legislation only imposes gains on direct transfers of the asset itself, companies may avoid the taxes by instead transferring the shares in a non-resident holding company, which owns or controls the resident subsidiary that holds the mining license. Governments may get around this by providing in law that capital gains tax also applies to gains made by the sale of shares in an entity that indirectly holds an interest in the license. Governments should consider what kind of information on ownership and ownership changes it should require companies to submit to properly identify events that trigger capital gains tax. Disclosure of beneficial ownership of license holders, now required under the 2016 Extractive Industry Transparency Initiative Standard, may be a useful tool for administering capital gains taxes. Governments should also consider the treatment of farm-out agreements (more common in oil and gas), where a portion of the interest in a mining license is assigned to another entity who pays a share of the ongoing costs. Often, no cash is transferred for the assignment. In determining how or whether to subject farm-outs to capital gains taxes, governments must balance the risk of farm-outs being used to avoid capital gains tax against the risk of discouraging investors from adding partners, which allows investors to spread the risk and increases the chances of the mining project moving forward to development.

Governments should also consider the impact of tax treaties on the ability to impose capital gains taxes on indirect transfers (where both buyer and seller are non-resident). Tax treaties may restrict the imposition of capital gains taxes on residents of a country with which the government has a treaty. Governments should consider whether the domestic legal framework allows for the overriding of treaties by legislation and the potential impacts of such a treaty override.

Enforcing capital gains taxes against non-residents may also be difficult. For this reason, some countries choose to deem the gain and the cost of the transfer as being incurred by the corporate entity resident in the country.

Capital gains taxes have often led to tax disputes between governments and investors. The best way to avoid such costly conflicts is to have strong and clear provisions in general legislation and regulations, as investors will factor in payment of capital gains taxes in the pricing of a transfer. Such provisions should be clear on whether the capital gains taxes extend to indirect transfers and provide exemptions for publicly traded companies, where shares are bought and sold on an open market.

36.3(g). Example 1:

Article [_]

(1) Subject to this Schedule, income in respect of which tax is chargeable under section 3(2)(f) is the whole of a gain which accrues to a company or an individual on or after lst January, 2015 on the transfer of property situated in [country], whether or not the property was acquired before lst January,2015

(2) Subject to section 15(5A), the net gain derived on the disposal of an interest in a person, if the interest derives twenty per cent or more of its value, directly or indirectly, from immovable property in [Country].

(3) “Net gain”, in relation to the disposal of an interest in a person, means the consideration for the disposal reduced by the cost of the interest.

(4) A licensee or a contractor shall immediately notify the [Regulating Authority], in writing, if there is a ten per cent or more change in the underlying ownership of a licensee or contractor. If the person disposing of the interest to which the notice above relates is a non-resident person, the licensee or contractor shall be liable, as agent of the non-resident person, for any tax payable under this Act by the non-resident person in respect of the disposal.

(5) For the purpose of section 3(2)(g), the amount of the net gain to be included in income chargeable to tax is-

(a) if the interest derives more than fifty per cent of its value, directly or indirectly, from immovable property in [Country], the full amount of the net gain; or

(b) for any other case, the amount computed according to the following formula-

AxB/C

(6)Where –

A is the amount of the net gain;

B is the value of the interest derived, directly or indirectly, from immovable property in [country]; and

C is the total value of the interest

(a) A gain on transfer of securities traded on any securities exchange licensed by the [Regulating Authority] is not chargeable to tax under this section.

Annotation

Drawn from Kenya’s Income Tax Act (as amended in 2014 and 2015), these provisions cover several of the issues surrounding taxation of capital gains.

The provisions allow for taxation of the gains from both direct and indirect transfers. The amount of the gain to be taxed is based on the extent to which the transferred interest derives its value from immovable property in Kenya.

The provision addresses the difficulty of enforcing capital gains taxes against non-resident persons, in the case of indirect transfers, by providing that the license holder in Kenya shall be liable for payment of such taxes.

Finally, an exemption is made for publicly traded securities.

36.3(g). Example 2:

Article [_]

(1) At the moment the underlying ownership of an entity changes by more than fifty percent as compared with that ownership at any time during the previous three years, the entity shall be treated as realising any assets owned and any liabilities owed by it immediately before the change.

(2) Where there is a change in ownership of the type referred to in subsection (1), after the change the entity shall not be permitted to –

(a) interest carried forward that was incurred by the entity prior to the change;

(b) deduct a loss that was incurred by the entity prior to the change;

(c) in a case where the entity has, prior to the change, included an amount in calculating income, claim a deduction under those provisions after the change;

(d) carry back a loss that was incurred after the change to a year of income occurring before the change;

(e) reduce gains from the realisation of investment assets after the change by losses on the realisation of investment assets before the change; or

(f) carry forward foreign income tax that was originally paid with respect to foreign source income derived by the entity prior to the change.

(3) Where there is a change in ownership of the type referred to in subsection (1) during a year of income of the entity, the parts of the year of income before and after the change shall be treated as separate years of income.

(4) This section shall not apply where for a period of two years after a change of the type mentioned in subsection (1), the entity –

(a) conducts the business or, where more than one business was conducted, all of the businesses that it conducted at any time during the twelve month period before the change and conducts them in the same manner as during the twelve month period; and

(b) conducts no business or investment other than those conducted at any time during the twelve month period before the change.

Annotation

Drawn from Tanzania’s Income Tax Act (as amended in 2012), this provision addresses the difficulty of enforcement of capital gains taxes against non-residents by deeming an indirect transfer a disposal and reacquisition by the resident entity of all its assets and liabilities. This results in a domestic capital gain and the tax can be enforced against the resident taxpayer (the license holder).

Once the license holder experiences a direct or indirect change of control (more than 50%), the entire gain is taxed. However, note that some countries choose to tax only the part of the gain that derives its value from the immovable property in the taxing country (for example, Kenya).