By Scott Sellwood, Oxfam America
This post originally appeared on politicsofpoverty.oxfamamerica.org on September 20, 2017
New research from Oxfam’s partners in Peru shows – yet again – how hard it can be for governments to protect the tax base over the life of a mining project (and hold mining companies accountable).
For many countries, tax and other payments from oil and mining companies represent an important source of government revenue. A case in point is Peru, where the government receives billions each year from companies in the extractive sector. But is Peru receiving all that it should be from these companies?
Last month, Peru’s Supreme Court ruled that its tax regulator (SUNAT) could finally recover millions in lost revenues from Peru’s largest copper mine, Cerro Verde. For the last six years, SUNAT has fought to recover $250 million in unpaid mining taxes between 2006 and 2009. Of this, $140 million is due to be paid to the local government of Arequipa – the region where the mine is located – under Peru’s decentralized mining, oil, and gas revenue sharing rules. These payments will help pay for urgently needed public investments. The Supreme Court appeal was the latest attempt by Cerro Verde to avoid paying what the government says is due.
Oxfam’s partner, Grupo Propuesta Ciudadana (GPC), has followed the Cerro Verde case closely and analyzed the publicly available data. At the center of the now six year fight to recover the lost millions is a tax stabilization agreement signed by then-President Alberto Fujimori in 1998, who is now imprisoned for corruption and gross human rights violations. The company argues that this agreement entitled it to tax exemptions related to its first major expansion investment in 2006 when it invested $900 million to nearly triple its annual production. Peru’s tax regulator disagrees, as do their courts.
Peru is right to be pursuing these unpaid taxes—but what if this is just the tip of the iceberg? GPC argues that they should be trying to recover more from the Cerro Verde mine. Their analysis shows that between 2006 and 2011 the mine failed to pay an additional $200 million in taxes. Cerro Verde, in their own financial statements, state that if they lose all the appeals they will owe $544 million in unpaid taxes between 2006 and 2013.
Further, between 2005 and 2012 (the “boom” years for mining companies around the world) GPC estimates that Cerro Verde generated upwards of $5 billion in tax credits, as a result of overly generous fiscal terms. And last year, a second major investment by Cerro Verde allowed copper production to further double (500,000 tons in 2016). This is a major concern for the tax justice groups in Peru. Basically, despite production increasing and commodity prices recovering, a second tax stabilization agreement signed in 2015 (allowing for accelerated capital depreciation) is likely to mean that Cerro Verde’s taxable income for the next few years is effectively zero.
These discretionary tax exemptions are already having a huge impact on budget transfers to Arequipa: since 2012, subnational transfers from mining have collapsed (from an average of 70 percent in 2012 to just 2 percent in 2016). GPC cautions that these revenues are unlikely to recover until 2019 or 2020, at the earliest.
In just the last two years Oxfam has commissioned similar case study research in Cambodia, Kenya, Malawi, Zimbabwe, and Niger—which each map government risks to revenue. Understanding oil, gas, and mine economics at the individual project level allows us to understand how national tax policy, royalty policy, subsidies and other investment incentives affect the amount and timing of revenue being produced by extractives projects for government coffers – and then into investments that yield inclusive human development outcomes. For our partners and allies, it is at the project level where revenues are secured or lost and it is where the real transformative potential for those revenues to support pro-poor development outcomes rests – as opposed to “economic growth,” and its often false promises of sustainable and inclusive jobs, infrastructure, or voluntary corporate social responsibility commitments.
Like the Cerro Verde case, these case studies show how countries that are heavily dependent on minerals or hydrocarbons for government revenues lose taxes from a combination of poorly negotiated, overly generous, and secretive contracts, and weak fiscal regimes vulnerable to abuse. Unlike Peru, not all governments have the wherewithal to audit multinational mining companies, and stay the fight through years of appeals.
But it’s not all doom and gloom. Despite the seemingly infinite ways large mining, oil, and gas companies can avoid paying taxes in countries where they work – as new research from PWYP Canada shows – the pathways are not unlimited. There are clear patterns and concrete legal, policy, and administrative solutions that can minimize these risks.
In Peru, for example, the government should:
Peru’s fight to recover lost revenues is not unique. Too often, countries with significant mineral, oil and gas resources fail to secure a fair share of the revenues generated by these projects. Such losses (which some global estimates put in the billions) are, quite simply, a matter of life or death. The lost billions represent money that should have been spent on building schools and hospitals, paying teachers, doctors and nurses, and providing equal access to safe drinking water or health care, among other urgent development priorities.
For more than ten years, Oxfam has fought for law and policy reform to require public disclosure of project-by-project payments, contracts, and beneficial ownership. We continue to defend anti-corruption laws like Section 1504 of Dodd-Frank and are now seeing a flood of new disclosures from laws in the EU and Canada. These long fought for gains are now allowing us to better understand how individual mining, oil, and gas project revenues are lost and we are ramping up our campaigns to stop them.
Scott Sellwood is a Program Advisor for Extractive Industries at Oxfam America.
By Kathleen Brophy, Oxfam America, and Eneya Maseko Oxfam in Zambia
This post originally appeared on politicsofpoverty.oxfamamerica.org on September 29, 2017
How detecting and deterring “transfer mispricing” in Zambia’s billion dollar mining sector can boost government coffers in a time of fiscal crisis.
Corporate tax dodging is not a victimless act. When corporations employ aggressive means to avoid paying tax in developing countries, citizens inevitably foot the bill. Corporate tax avoidance deprives governments of desperately needed tax income for the provision of public goods and services forcing governments to choose between cutting public services or collecting additional tax from citizens. So, while companies report eight and nine figure profits, citizens face eroding hospitals and schools and struggle to pay higher prices for basic goods. However, when companies do this while in the process of extracting a high value, exhaustible commodity from beneath citizens’ feet, the offense is all the more egregious.
According to the Mbeki High Level Panel on Illicit Financial Flows, multinational tax avoidance in the oil and mining sectors across Africa is rampant. In countries like Zambia, where extractive industries contribute a significant portion of the country’s overall revenues, preventing aggressive tax avoidance is all the more critical for reducing inequality. This is especially true now in the context of Zambia’s fiscal crisis as the country turns to the IMF and capital markets for fiscal support.
According to a report by the Natural Resource Governance Institute, the mining sector in Zambia accounts for nearly 80 percent of all exports, contributes 12 percent of the country’s GDP and 30 percent of its tax revenue. Despite such positive statistics, ample evidence suggests that the Zambian government also loses a significant amount of mining sector revenue due to tax avoidance by multinational companies operating there as well as lax government regulations and enforcement. It doesn’t have to be this way. Governments are not powerless and can enact strong regulations to help prevent corporate tax avoidance. The situation in Zambia shows how relatively concrete actions taken by government could make a big difference.
Reforms necessary to address avoidance
One central tax avoidance tactic used in the Zambian context is transfer mispricing. Transfer mispricing involves the manipulation of prices used in a sale between two associated companies that serves to artificially shift profits out of a given country to reduce taxes owed. For instance, a subsidiary of a multinational mining company operating in Zambia could sell copper to an affiliated company in Switzerland at an artificially low price in order to minimize its income tax liability in Zambia and transfer the income to Switzerland, thus misrepresenting the true value of the minerals sold and depriving the Zambian government of tax revenue due.
The central challenge for regulators, tax authorities, and oversight institutions is to determine whether transfer mispricing has, in fact, occurred. The example above illustrates one basic challenge for regulators: to determine whether the price at which the mineral or another good was sold or a service rendered between related corporate entities was done at a fair market price.
In order to do this, tax authorities must be able to assess the validity of the transactions by comparing a transaction between two associated entities with other similar market transactions. For tax authority officials in Zambia to undertake this type of comparable analysis, tax authorities and oversight bodies must have the necessary information regarding all controlled transactions between Zambian-based mining companies and their associated entities. Without this basic information, the Zambia Revenue Authority is unable to monitor risky transactions and identify potential transfer mispricing.
Governments around the world commonly require transfer pricing documentation from companies so they must maintain, if not regularly submit, timely and accurate information about their related party transactions. However, there is currently no legal requirement in Zambia for the maintenance of transfer pricing documentation. This oversight is a significant obstacle to tackling transfer mispricing since government officials do not have the basic information they need to monitor and evaluate related party transactions.
Furthermore, Zambia’s Income Tax Act, which could be used to regulate transfer pricing losses, currently mandates that mineral prices used in transactions between related entities be based on a reference price from an international exchange market. Unfortunately, the law also allows companies to make adjustments to the price used in transactions to account for specific details that may affect the price downward, such as ore quality. While this is a reasonable allowance, it does pose risk for abuse. This allowance increases the regulatory burden for the government, as it must also be able to evaluate the complex mineral valuation formulas used by companies to underpin the prices used in transactions.
In order to verify the valuation used by companies, the Government of Zambia must independently assess mineral quality. Mineral valuation responsibilities, including the monitoring of mineral exports, are shared between the Ministry of Mines and the Zambia Revenue Authority, along with other agencies all part of an initiative called the Mineral Value Chain Monitoring Project. While agencies are coordinating their work through the initiative, the protocol for mineral valuation procedures between agencies and the agency with ultimate jurisdiction over the matter is still unclear.
Progress made while key gaps remain
Recognizing these challenges and the need to increase revenue collection from the mining sector, the Government of Zambia has recently expanded efforts to improve mining oversight and prevent transfer mispricing. For instance, the government revised the Income Tax Act, strengthening Section 97 which sets out general transfer pricing guidelines and establishes the use of the arms-length standard as the basis for pricing all transactions between associated entities.
Such efforts are in line with ongoing efforts by Oxfam Zambia and partners including the Zambia Tax Platform to strengthen revenue generation, tax policy and payment transparency in the country’s mining industry.
Oxfam welcomes the efforts of the Zambian government to protect the mining tax base by improving its legal and regulatory capacity to address transfer mispricing in the mining sector. Additionally, the government of Zambia must build on its existing practice, and require transfer pricing documentation in the forthcoming regulations (“statutory instruments”) to the Income Tax Act. The regulations for the Income Tax Act should also include clear protocols for coordination between government agencies for the independent valuation of minerals.
While the regulations have stalled for some time, it is important that they are passed without further delay so as to provide a strong basis for regulating transfer pricing in Zambia’s mining sector.
With these changes, Zambia will have a better chance of capturing much needed tax revenue from corporate tax payers, preventing the need to make regressive policy choices that hurt Zambians.
This post was co-authored by Kathleen Brophy, Program Officer for Accountable Development Finance at Oxfam America, and Eneya Maseko, Program Coordinator for Extractive Industries for Oxfam in Zambia.
The following case study is part of the Publish What You Pay International Secretariat’s Data Extractors program, a global initiative that trains Publish What You Pay members and activists around the world to put extractives data to use to fight for a more open and accountable natural resource sector.
This case study began with a not-so-simple question: Is the United States getting a good deal for the depletion of its natural resources?
Publish What You Pay – United States ( PWYP-US) has worked for 13 years to open the books of oil, gas and mining companies to create a more open and accountable extractives sector. More than a decade into this effort, many of the world’s largest oil, gas and mining companies now disclose their project-level payments to governments, either voluntarily or in compliance with legal requirements. Yet, a few major US oil companies – namely ExxonMobil, Chevron and ConocoPhillips – remain strongly opposed to these simple financial disclosures.
Like the citizens in resource-rich countries around the world, citizens of the United States also need to know if they are getting a good deal on their natural resources. Thoroughly answering this question, however, is incredibly complex and involves the careful analysis of contracts, as well as relevant tax and royalty regimes governing the extractives sector. As a starting point, this case study focuses on how much some of the largest extractives companies paid in taxes to the US federal government in 2015.
Read the full case study on the Publish What You Pay International Secretariat site.
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