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Part C: Fiscal Terms - 36. Fiscal Terms - 36.3 Taxes | 36.3(h). Windfall Profits

Resource rent taxes (RRTs) are taxes on the resource rent generated by a project. Resource rent may be defined as the surplus value generated by a project over all necessary costs including a return on capital sufficient to attract investment. For example, if a return of 15% would be required to attract investment, rent would be any return beyond 15%.

In principle, RRTs are valuable for governments in two respects. First, RRTs are tax neutral; that is, they allow the government to maximize revenue collection without deterring investment since in theory they tax returns beyond what would be necessary to attract investment in the first place. Second, RRTs provide the fiscal regime some flexibility to changing conditions by responding more quickly than legislative or contractual changes allow and reducing pressure on governments to renegotiate terms when prices soar. The greater flexibility that can be achieved by use of RRTs can reduce investors’ expectations of political risk and fear that governments will seek to change the terms after costs have been sunk.

There is no common design to an RRT, with each country applying their own approach. However, an RRT will typically have three elements:

1. A specified rate of return on investment that triggers the imposition of the tax

2. Specified tax rate on net profits once the rate of return has been exceeded; and

3. The tax base, which is typically an individual mining project (i.e. ring-fenced from other projects within a corporate entity) and allowable deductions.

In order to achieve tax neutrality governments should ideally set the rate of return trigger so that the tax is only triggered once the company’s investors are making the required return on their capital. In practice, triggers are often set in legislation and thus apply across multiple projects that are likely to have different risk characteristics and investors with different expectations of return. Further, governments should consider the impact of other tax instruments on investors’ returns and accommodate these in setting the trigger.

In principle, any return beyond that required by companies to invest could be taxed at 100%. In practice, however, governments choose much lower rates (10 to 40%) to account for not being able to accurately set triggers and tax bases that define resource rent.

Ideally the tax base to an RRT should be an individual mining project, ring-fenced from other projects, to ensure that the RRT applies to the specific rent generated by a project. In addition, governments should consider what exploration costs to include in the base.

Depending on what tax base governments set, administration of RRTs need not be any more complicated than corporate income tax. However, additional difficulties are two-fold. First, RRTs typically require monitoring accumulated profits from the beginning of a project (although a tax authority should also monitor these profits for corporate income tax). Second, choosing a tax base definition that requires additional measurement of company activities will create further tasks for the tax authority.

Lastly, some countries have levied taxes that are similar to RRTs but trade off neutrality for simplicity by, for example, using variable rate income tax (see Ugandan example below). It is also possible to emulate the effect of an RRT using certain designs of a production sharing arrangement (with the share to the government increasing if some proxy for profitability increases such as mineral price, cumulative production, or revenues divided by costs), or by acquiring equity via certain carried interest arrangements, which may allow the government to capture rents as dividends.

36.3(h). Example 1:

Article [_]

(1) The income tax rate applicable to companies, other than mining companies, for the purposes of section 7 is 30 percent.

(2) Subject to paragraphs (3) and (4), the income tax rate applicable to mining companies is calculated according to the following formula-

70 – 1500/X

Where X is the number of the percentage points represented by the ratio of the chargeable income of the mining company for the year of income to the gross revenue of the company for that year.

(3) If the rate of tax calculated under paragraph 2 exceeds 45 percent, then the rate of tax shall be 45 percent.

(4) If the rate of tax calculated under paragraph 2 is less than 25 percent, then the rate of tax shall be 25 percent.

(5) In this Part-

(a) “gross revenue”, in relation to a mining company for a year of income, means-

(i) the amount shown in the recognised accounts of the company as the gross proceeds derived in carrying on of mining operations during the year of income, including the gross proceeds arising from the disposal of trading stock, without deduction for expenditures or losses incurred in deriving that amount; and

(ii) the amount, if any, shown in the recognised accounts of the taxpayer as the amount by which the sum of the gains derived by the taxpayer during the year of income from the disposal of business assets used or held ready for use

in mining operations, other than trading stock, exceeds the sum to losses incurred by the taxpayer during the year in respect of the disposal of such assets; and

(b) “mining company” means a company carrying on any mining operations in [Country].

Annotation

Drawn from Uganda’s Income Tax Act (2016), these provisions provide an example of taxation of mining profits using a ring-fenced Variable Rate Income Tax. Under this arrangement, the rate of tax in any accounting period is derived using a formula that measures the ratio of taxable income to gross revenues. This ratio is typically designed to apply if it does not fall below or above certain fixed low and high limits. The effect of such formulas is progressive, because they take into consideration the relationship between costs and revenues in a similar manner to the rate of return calculations.

36.3(h). Example 2:

Article [_]

A tax, to be called minerals resource rent tax, shall be charged in the circumstances stated in and in accordance with the provisions of the relevant mining agreement, and at the rate or rates specified in, or determined in accordance with, that agreement. The minerals resource rent tax shall be assessed in respect of a mining area in accordance with the mining agreement. Where, for any tax year, there is only one party to the relevant mining agreement, that party shall be liable to pay any minerals resource rent tax payable in respect of that tax year. Where, for the whole or any part of any tax year, more than one person is a party to the relevant mining agreement, those persons are jointly and severally liable to pay any minerals resource rent tax payable in respect of that tax year; but without prejudice to any claim, or the enforcement of any claim, which any such person incurring any such liability may have against another person in respect of that liability.

Annotation

This constructed provision recognizes that the main trigger element of a resource rent tax (i.e. a rate of return on investment) will vary due to factors ranging from investor hurdle rates on a project-by-project basis to prevailing commercial and technological conditions during the mine development planning stage. Therefore the trigger rate of return, specified tax rate (s) and the tax base are left to be determined by contract while the income tax law, which typically has provisions specific to mining operations, would require the imposition of a resource rent tax. The 2013 Model Petroleum Agreement of Seychelles (s. 13 on Petroleum Additional Profits Tax) can provide an example of contractual language for resource rent tax.