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Part C: Fiscal Terms - 36. Fiscal Terms | 36.5 Tax Holiday

Tax holidays are one of several tax incentives that may be granted to investors to attract investment. Tax holidays refer to exemptions a mining law may grant to a license holder from payment of some or all taxes for a defined period of time.

In general, tax holidays, like tax incentives generally, should be used with caution. Use of tax holidays can significantly reduce or delay revenues to governments. Moreover, tax holidays are open to abuse. For example, depending on the length of the tax holiday and other conditions, mines can go into full production while a tax holiday is still in effect and investors might be incentivized to maximize production while the holiday is in effect and reduce production once the holiday comes to an end. Tax holidays may also encourage abusive transfer pricing and other practices aimed at reducing tax liability by shifting profits to jurisdictions benefiting from low or no taxes. The transition to regular taxation may be administratively difficult, especially if records were not adequately kept during the holiday and the treatment of depreciating assets may not be clear.

Further, tax holidays and other incentives are used on the premise that they are necessary to attract foreign direct investment. However, research indicates that tax holidays can be ineffective in promoting the desirable activities linked to the incentive and investment decisions for foreign investors are informed by a broader set of considerations beyond tax incentives (for example, infrastructure, low administrative costs of setting up and running businesses, political stability and predictable macro-economic policy). Research also indicates that other tax incentives such as investment credits, investment allowances and accelerated depreciation may be more cost-effective for countries seeking to promote investment than tax holidays.

Competition for foreign investment can lead to a “race to the bottom.” Therefore, it is advised that tax holidays and other incentives, if used at all, should be used only after a careful cost-benefit analysis and coordination among regional economic communities to develop common standards and prevent a race to the bottom. The use of tax holidays should also be transparent, to avoid their use by officials unilaterally on a per-contract basis in exchange for personal benefit.

It is recommended that, to the extent used, tax holidays be structured as follows:

  • Limit the duration to the minimum time period possible but no longer than the earlier of five years or recoupment of initial capital costs.
  • Begin at the latest at the date of first commercial production.
  • The tax holiday should provide for a 0% tax rate during the holiday. The taxpayer should be required to file audited returns each year, taking all deductions required or allowed for that fiscal year, but paying tax at a zero rate. This will limit the administrative difficulties of transitioning to regular taxation after the holiday.

36.5. Example 1:

Article [_]

(1) Profits of companies shall be taxed at 0% for mining projects in Zone I areas for a period of the earlier of five years starting from the beginning of the first fiscal year following the commencement of commercial production or the recoupment of initial capital costs. During the duration of the tax holiday a company must file a tax return for each fiscal year, taking all deductions required by law, including, but not limited to, exploration expenses. If the result of the computation results in a tax loss in that fiscal year, the company will be allowed to carry forward the tax loss to subsequent periods subject to applicable rules on loss carry forward.

(2) Zone I areas are defined as areas of strategic importance for foreign investment included on a list published in regulations issued by the [Regulating Authority].

Annotation

This constructed provision prevents the investor from carrying forward losses almost indefinitely by applying unused deductions after the holiday, which, in addition to carrying loss forward could result in the non-payment of taxes for several years.

The provision is constructed as a tax incentive for investment in areas of “strategic importance.” These may be remote areas, for example, where the government wants to promote investment and associated infrastructural development.

Despite the inclusion of the alternate five-year limitation, note that the term “capital costs” should also be defined for clarity. Investors might want to add financing costs, for example, or higher measures of the cost of capital, which could make what constitutes “capital costs” very broad.

36.5. Example 2:

Article [_]

(1) The tax relief period of a company granted mining rights under this [Act][Code][Law] shall commence on the date of operation and subject-to the provisions of this Act or any other relevant financial enactment, the relief shall continue for three years.

(2) The tax relief period of a company granted a mining right under this [Act][Code][Law] may, by the end of the three years, be extended by the Minister for one further period of two years.

(3) The [Regulating Authority] shall not extend the tax relief period of a company in exercise of the power conferred under subsection (2) of this section unless the [Regulating Authority] is satisfied as to-

(a) the rate of expansion, standard of efficiency and level of development of the company in mineral operations for which the mining right was granted;

(b) the implementation of any conditions upon, which lease was granted; and

(c) the training and development of [Country’s] personnel in the operation of the mineral concerned.

Annotation

Taken from Nigeria’s mining code (2007), this provision does not provide blanket tax relief for all mining companies, but sets some parameters for the grant of tax relief, including that it must begin on the “date of operation” and may be granted for up to five years.

Since the provision does not apply to all companies, some transparency in the grant of tax relief (for example, disclosure of contracts) and extension of tax relief may be warranted.

If such a general provision were used in law, regulations would need to spell out more details of the nature of the tax relief (whether just corporate income tax or other taxes and whether the rate is 0% or simply a rate below the generally applicable rate), the basis upon which it may be granted (for example, to promote investment in certain high risk areas), on meaning of “date of operation” and on the administrative obligations of the company during the period of tax relief with respect to filing tax returns. As in the example above, regulations should also provide clarity on application of deductions and use of loss carry forward during the tax holiday period.