The application of global tax reforms to the extractive industries

Cross-posted from the International Tax Review.

In this article I investigate whether IMF and OECD proposals on how to tax the digital economy, apply formulary apportionment, shift taxing rights and address profit shifting could apply to the natural resource sector. Alternatively, could improvements to source-based taxation hold the answer?

There are potentially large changes afoot in how the profits of multinationals are taxed. Motivated by the challenge of taxing the digital economy, the OECD is considering shifting some taxing rights into the market or destination country. The IMF is taking a broader view of corporate tax reform, with particular concern for the vulnerability of developing countries to profit shifting activities. 

However, neither proposal examines the options for taxing the extractive industries – mining, oil and gas.The OECD’s programme of work on digital tax reform suggests that commodities are likely to be left out of future developments (see OECD, ‘Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy’, May 2019). In an earlier paper the IMF acknowledged that most of the policy options for corporate tax reform, with some exceptions, may not be suitable for natural resources (see IMF, ‘Corporate Taxation in the Global Economy, March 2019). 

That is because source-based taxation is considered the most appropriate model of taxation for natural resources, which are location-specific. The intuition is right: resource-rich countries should get the lion’s share of the fiscal benefits from resource extraction. The challenge is that source-based taxation of natural resources is also vulnerable to profit shifting. 

Take for example, the court case in Australia against oil and gas company, Chevron. In Chevron Australia Holdings Pty Ltd v. Commissioner of Taxation, the Federal Court upheld the Australian Taxation Office’s (ATO’s) finding that Chevron had used a series of intra-company loans to shift profits offshore. The company was ordered to pay A$300 million ($209 million). 

Developing countries, on the other hand, simply cannot afford such a dispute, which cost the ATO A$10 million in legal fees, and is the equivalent of 45% of the Sierra Leonean tax authority’s total operating budget ($16.4 million) for 2016. Even common profit shifting challenges, such as intra-firm lending, loom especially large because of the scale of operations and the significant revenues at stake (see Figure 1). 

It is therefore necessary to determine whether the alternative models of taxation being considered, that are more robust against profit shifting, could also apply to natural resources. 

Figure 1. Resource revenue as a percentage of total revenues 

Source: Author’s estimates using the Government Revenue Dataset (ICTD) and EITI data

Source: Author’s estimates using the Government Revenue Dataset (ICTD) and EITI data


DBCFT and the ‘marketing intangibles proposal’


The proposed destination-based cash flow tax (DBCFT) is a levy on corporate income based on where goods end up, rather than where they were produced.Despite being more robust to profit shifting, resource-rich countries are unlikely to agree to let the profits from their natural resources be taxed in the customer’s location. 

The IMF paper, entitled ‘Corporate Taxation in the Global Economy’, estimated that resource-rich countries stand to lose 1% of GDP under such a tax. That is not a concern just for developing countries: In 2017,63% of Australia’s mineral and metal exports ($60.2 billion) went to China, whereas China accounted for only 24% of Australia’s imports.

Similar problems could arise if marketing intangibles are adopted for residual profit allocation, as proposed by the OECD. The dispute between the ATO and BHPregarding the company’s offshore marketing hub is a case in point. BHP was allocating a large portion of the profits from the sale of Australian iron ore to its hub in Singapore based on marketing intangibles. The ATO rejected the arrangement, leading to a large tax adjustment and to BHP increasing its ownership of the hub so that all profits in Singapore stemming from Australian mines are taxed in Australia. 


Formulary apportionment

Alternatively, formulary apportionment – or ‘fractional apportionment’, as the OECD is calling it – could apply to the extractive industries, but there are challenges. 

First, a formula that appropriately compensates the producing countries would need to be determined. Consider, for example, Rio Tinto and Anglo American’s global profits for 2017, shown in Figure 2 and 3. From the perspective of producing countries, the worst scenario is if profits are allocated to where the minerals are sold, for example, China, Europe and the US. A better model is if profits are apportioned equally between sales, assets, and employees. An even better result for Anglo American's mines is if the formula is modified to include assets and an ‘extraction factor’ (that is, total production, as in Alaska). The exception is South Africa and Chile, which receive a greater share of global profits if assets and employees are used.

Rio Tinto's mines, on the other hand, while better off under the 'Alaska model', receive the greatest share of global profits under assets and employees, although Australia is an exception. 

While it seems counterintuitive that producers would get more global profit under assets and employees than assets and production, a mine’s contribution to total production will depend on its stage of development. 

In Mongolia, for example, Rio Tinto’s Oyu Tolgoi copper mine is under construction and yet to ramp up production. Consequently, Mongolia’s share of total production is less than its share of total employees; thus, Mongolia receives less profit when production, rather than employees, are used to allocate profits. 

It may also depend on the commodity as some are more labour intensive than others.For example, platinum mines are typically more labour intensive than other commodities, which is why Anglo American's employment data for South Africa is significantly higher than elsewhere. Both these examples demonstrate the need for careful analysis of apportionment factors over life-of-mine and for different commodities.


Figure 2. Apportionment of Anglo American’s global profits under four models of formulary apportionment (2017) (%)

Source: Anglo American’s annual report (2017) for accounting information. Data used is illustrative.

Source: Anglo American’s annual report (2017) for accounting information. Data used is illustrative.

Figure 3. Apportionment of Rio Tinto’s global profits under four models of formulary apportionment (2017) (%)

Source: Rio’s annual report (2017) for accounting information. Data used is illustrative.

Source: Rio’s annual report (2017) for accounting information. Data used is illustrative.

Another challenge for formulary apportionment involves intermediary mineral products. Many resource-rich developing countries export unfinished raw materials that are transferred to a related-party refinery for further processing before sale. 

Rio Tinto, for example, operates a mineral sands project in Madagascar. It produces ilmenite, which contains 60% titanium oxide. The raw material is shipped to Rio Tinto’s Fer et Titaneprocessing plant in Canada, where it is transformed into a 90% titanium dioxide chloride slag. A formula would need to apportion profits for the raw material extracted in Madagascar, as well as value added outside the country. While many diversified miners produce financial information by business unit (for example, iron ore, copper), further disaggregation of the relative costs of production and overheads would be required to set an appropriate formula for each commodity.

There is also a question of whether to use assets’ accounting value or fair market value. The difference may be quite substantial. For example, the accounting valuing of Rio’s Australian iron ore operating assets are $16 billion, whereas the market value is more than $50 billion. While the market value may be a more relevant basis for profit allocation – Australia’s tax take would be much higher, for example – the historical cost of purchase is more objective and easily verified.

Finally, resource-rich countries would need to be willing to accept global offsetting of corporate losses. Consider Anglo American’s operations in Brazil and Chile. If the Brazil mine incurs a loss, the company can offset that against the tax base of the mine in Chile, whose government thus gets less revenue from its minerals. 

From the taxpayer’s perspective, it is only fair that if income from Brazil can be included in Chile’s tax base, so too should a corollary loss. Chile, however, may disagree that the compensation it gets for its minerals should be impacted by activities in Brazil. Whether it is worthwhile for Chile and Brazil will depend on careful analysis of the risk to revenue under international tax rules and whether both countries would on average be better off under formulary apportionment.


Minimum tax on inbound investment

The OECD and IMF are also considering a minimum tax on inbound and outbound investment. A minimum tax on inbound investment should reduce cost-based profit shifting – a major concern for resource-rich developing countries that depend on foreign capital to develop their mineral deposits. It would also limit countries’ use of tax incentives, which could affect investment, although is a smaller concern in mining given investment is tied to a fixed resource and therefore less mobile.

While a minimum tax on inbound will help reduce cost-based profit shifting, extractive companies might still understate the value of mineral sales. However, for widely traded products (for example, precious metals and crude oil), that problem can be addressed through greater use of benchmark prices. Many Latin American countries already require taxpayers selling mineral products to offshore related parties to use the publicly quoted price to calculate corporate income tax (commonly known as the sixth method). For minerals that lack a market price, advance pricing agreements could be used to negotiate a pricing formula.


Source-based taxation for resource rents

Assuming that developing countries continue to use some source-based taxation for resource rents, the questions are what type of system and how resistant is it to profit shifting? 

There are several factors to consider when designing a resource tax system — efficiency and adaptability, for example. However, if vulnerability to profit shifting is taken in isolation, it is clear that some instruments are better than others. 

The main difference is between taxes on turnover and taxes on profits. Whereas a royalty is generally applied to the gross value of the mineral product, an income tax is applied to the taxpayer’s net profit. The base for corporate income tax will always be lower than the base for royalties. Corporate income tax is also more prone to tax avoidance because the base is net income. 

Another way for countries to capture the domestic value of their resources is by taking a share of the physical production. Theoretically, production sharing is less vulnerable to avoidance, provided there is a cap on how much of the production the investor can take to recover its costs.

To conclude, the international community will not be able to help developing countries meaningfully combat profit shifting without addressing the risks specific to the natural resources sector. 

Any proposal that aims to shift taxing rights to the market jurisdiction will not be appropriate for resource-rich countries and is likely to be met by significant resistance from governments. Formulary apportionment is more plausible, although further research is required. A minimum tax on inbound investment, combined with greater use of benchmark prices, and production-based taxes would go a long way in addressing profit shifting in the natural resource sector. No matter the system, coordination is key to prevent countries from increasing their exposure to tax-related competition and to avoid double taxation. Above all, it should be easier for developing countries to administer.  


This article is based on a presentation the author gave at the fifth annual World Bank Group/IMF Spring Meetings conference on taxation in Washington on April 14.

The data used is illustrative, taken from publicly available data that would need further breakdown to arrive at a more robust position. Rio and Anglo American were selected because of their advanced disclosure of data.


Storing the Power, Losing the Profit?  Allegations of Under-pricing of Lithium in Chile

Photo credit: Depositphotos/xura

Co-authored with Jaqueline Terrel. Cross-posted from Bloomberg Tax.

Amid allegations of transfer pricing abuse in Chile, the government needs to reinforce its monitoring of the lucrative lithium industry.

Last month, Chile’s government announced it was creating a committee to supervise lithium contracts the state has with U.S. based Albemarle, and local company, SQM; deals that are vital to the country maintaining its leading role in global lithium production. The declaration follows allegations about Albemarle charging below-market-prices for its lithium in sales to foreign affiliates. 

Between the Pacific Ocean and the snow-capped Andes, the Salar de Atacama is Chile’s largest salt flat, and the driest non-polar desert on earth; 130 feet below the surface of the lake, lays a brine which contains 27 percent of the world’s lithium, a silvery-white metal in the Earth’s crust. 

Lithium, or “white petroleum” as some call it, is used to produce batteries to power laptops, mobile phones, and iPods. Theturning point for the industry came in 2006 when Tesla announced plans for a battery-powered electric car with a range of 200 miles per charge. Since then, prices for the most common variety of lithium, lithium carbonate, have risen rapidly. According to metals and mining consultancy CRU, prices increased by 300 percent between 2015 and 2018 (see chart below). A report by Goldman Sachs in 2015 predicted that the size of the global lithium market could triple by 2025.

Screenshot 2018-08-15 11.48.41.png

Albemarle Corporation is one of the biggest winners in the lithium price boom. The U.S.-based company has 20 percent of world lithium market share. It owns lithium brine operations in the U.S.; a 49 percent stake in Greenbushes, the massive hard-rock lithium mine in Australia; and, in January 2015, it acquired the Rockwood Holdings Inc. lithium company in Chile. 


Allegations of Transfer Pricing Abuse

However, the lithium price surge has led governments to investigate whether they are getting full value for the resource. They are especially concerned about the potential for under-pricing of related party sales. 

“Transfer pricing” is a legitimate business practice; it is the process for determining the value of a transaction between two entities that are part of the same group of companies. However, there is a risk that companies will undercharge for production exported and transferred to related parties, in order to avoid taxes in the host country. 

In Chile, Albemarle sells much of its lithium production to affiliate companies in the U.S. and Germany. The former Vice-Presidentof Chilean Economic Development Agency (CORFO), the government agency that owns the subsurface resources of the Salar, has raised concerns about Albemarle’s sale price being lower than its local (and global) competitor, SQM. Eduardo Bitrán said "I noticed that until February of this year Albemarle sold lithium to its parent company at a lower price than other companies. If that is the case, it is undervaluing the product, and the tax authorities would be receiving less resources via taxes.”

The issue has become a hot topic in Chile. Using customs agency data, academics and the media have identified a difference of $1,800 on average between Albemarle and SQM’s sale prices for lithium carbonate in 2017. Data from the Chilean Copper Commission roughly supports this conclusion. It confirms that in 2017 the average price for total lithium exports (carbonate, oxide, and chloride) was $11,169, and $8,984 for SQM and Albermarle respectively (i.e. Albermarle’s price was lower by $2,185).

Based on Albemarle’s lithium production in 2017, the company would have collected $36 million less in sales revenue than had it used the same price for lithium carbonate as SQM. At a corporate tax rate of 25.5 percent, this amounts to approximately $9 million in forgone taxes. Assuming the average price difference stays the same, the tax gap is likely to increase to $18 million as Albemarle doubles its production in 2018.

Albemarle is also being investigated in Australia, in relation to the price at which it, and its Chinese partner Tianqi, bought lithium products from their subsidiary (Greenbushes mine) in 2015 and 2016. Windfields, the private company that owns the Greenbushes mine has conceded it could face a tax bill over sales to Albemarle and Tianqi for 2015 and 2016. 


Albemarle Rejects the Allegations in Chile

Albemarle claims that its lower export value compared to SQM is due to several differences:

  • the lithium products exported by Albemarle have different characteristics to SQM;
  • SQM refines its lithium more than Albemarle, which increases the value, and production costs;
  • Albemarle sells its lithium to different markets and end-users;
  • Albemarle sells its lithium via long-term sales contracts rather than spot sales which are likely to achieve higher prices.


A Review

The allegations of transfer pricing abuse will be discussed below, taking into consideration the differences highlighted by Albemarle.


1.Characteristics of Lithium Products

According to Albemarle’s website, it has been producing battery grade lithium carbonate, the same as SQM, since 2017. “Battery grade” lithium carbonate has a minimum of 99.2–99.5 percent carbonate content and reduced impurities: whereas “technical grade”, commonly used in the production of glass and ceramics, is typically composed of 99 percent lithium. 

According to sources, while the grade may be the same, unlike SQM, Albemarle is reporting penalties (chloride) in their exports. Lithium chloride is the original solution that is pumped from the Salar, and then treated with sodium carbonate toproduce lithium carbonate. The fact that Albemarle does less refining than SQM, which processes its lithium before export from Chile, may explain the difference in chloride levels, and subsequent penalties. 

However, even a relatively small difference in grade can have a big impact on price. Differences in the purity of the material, and production costs mean that battery grade is $1.00–$1.50 more per kilogram (or $1,000–$1,500 per tonne) than the technical grade. 


2. Value Addition and Processing Costs

SQM processes its lithium before export from Chile. First, the brine is pumped into evaporation pools where the sun concentrates it into a yellow greasy solution. The solution is then transferred to the Salar del Carmen production facility plant where it is purified and treated with sodium carbonate to produce lithium carbonate. Finally, the lithium carbonate is filtered, dried, and packaged for shipment. Value is added to the final product, and “the tax on this value added remains in Chile," a source says in a translated statement.

Source:  SQM

Source: SQM

Not only does the additional processing enhance the value of the product, but it also increases the cost of production. According to the Metals Bulletin, it costs $1 per kilogram to transform lithium carbonate into battery grade [by reducing impurities]. Assuming the cost is built into the final sale price, this would explain $1,000 of the $1,800 price gap between Albemarle and SQM.


3. Destination Markets and Sale Arrangements

Albemarle sells much of its lithium to its affiliate in the U.S., and some to Germany: SQM, on the other hand, sells a large amount of its production to affiliates in China for further processing

According to trade data, the value of Chile’s lithium carbonate exported to the U.S. is $1,700 less on average than the lithium going to China. This suggests that the implied price of lithium carbonate sold to U.S.-based entities is well below the price received in lithium sales to China.  The variance could be due to Chinese companies paying more for lithium in order to control the electric vehicle supply chain, plus the additional cost of shipping and transportation. There is also less cathode production in the U.S., which means lower battery grade lithium imports, and lower trade values.

Source: Comtrade

Source: Comtrade

While trade data cannot always be relied upon, according to the media, in 2017, Albemarle charged its U.S. and German affiliates an average of $6,665 and $7,287 per tonne of lithium, and its Chinese customers US$10,776—a difference of 63 percent. 


4. Long-term Sales Contracts Versus Spot Sale Prices

There is a spot market for lithium (i.e. buying or selling a commodity for immediate settlement), but volumes are very small. Most of global lithium production is sold via offtake agreements (i.e. an agreement entered into between a producer and a buyer to buy/sell a certain amount of the future production). Benjamin Jones, Managing Consultant at CRU said “according to our intelligence reported Lithium spot prices have been more volatile and well in excess of contract prices – more than 100% higher during most of 2016, with premiums falling to around 50-80% in the subsequent period.” This could explain the price difference if Albemarle is selling mainly via contract rather than spot.

In the past, there has been a lack of benchmark prices, making verification difficult for tax authorities. However, in 2017, the Metals Bulletin launched contract and spot reference prices for lithium carbonate. In future, the Internal Revenue Service of Chile (“SII”) could use the spot price on the date of signing as a reasonable guide to the average contract price, depending on offtake provisions, financing, and customer specifications. They could also demand that offtake agreements stipulate an annual price review to limit the risk of artificially low negotiated prices, as Galaxy Resources did in relation to its sales to customers in Asia. The London Metals Exchange also looks set to launch the world’s first lithium futures contract, which could be another useful data point for tax authorities.


How Should Chile Respond?

Corfo has requested that Albemarle sign an Advance Pricing Agreement (APA) with the SII. Albemarle’s Australian subsidiary also made a request to the Australian Tax Office (“ATO”) for an advance pricing agreement (“APA”) for 2015 and 2016. An APA is an agreement, usually for a fixed period, between a taxpayer and at least one revenue authority, specifying the chosen transfer pricing method that the taxpayer will apply to a particular controlled transaction; the revenue authorities commit to not making any adjustments during that period. The main advantage is that an APA locks in a method for determining the transfer price up front, reducing the need for complex transfer pricing analysis. Also, during the negotiation, the SII would get access to detailed pricing information from Albemarle that would help build its industry knowledge. 

The SII could also make a request to the ATO for information regarding Albemarle’s operations in Australia. In 2013, Chile and Australia signed a Double Taxation Agreement (“DTA”). Under the DTA, SII can request such information from the ATO that would be helpful in preventing tax avoidance—for example, information on Albemarle’s operations, pricing structures, and production costs, bearing in mind that the Greenbush mine produces hard-rock lithium rather than brines. In the past year, Chile’s state-owned mining company, Codelco, has also entered the lithium space, providing a future source of industry information, as well as domestic comparables.


A Chinese Monopoly—a Further Transfer Pricing Risk?

 Earlier this year, Tianqi, the Chinese company, paid $4.1 billion to become the second-largest shareholder in SQM. Along with the stake in SQM, Tianqi owns 51 percent of Australia’s Greenbushes mine in a joint venture with Albemarle. As a result, the company now has effective control over nearly half the current global production of lithium, as well as a monopoly in Chile.

Corfo has complained that Tianqi’s control on lithium could “gravely distort market competition”. In terms of transfer pricing, the monopoly could further reduce the volume of independent transactions available to generate appropriate benchmarks, making it even harder than it is currently for tax authorities to verify related party sales.


Planning Points

It is unlikely the price difference between Albemarle and SQM is evidence of transfer pricing abuse. The $1,800 average price gap in 2017 is largely explained by 1) Albemarle exporting a lower grade product due to less refining and more chloride; 2) reduced production costs than if it processed its lithium before export; and 3) price disparity between lithium sold to the U.S. versus China. 

However, Corfo and others are right to be concerned about the risk of Albemarle (and SQM for that matter) under-pricing lithium sold to affiliates. Large-scale lithium production is relatively new; hence tax authorities are scrambling to get up to speed on what it is, and how it is priced. It is also an opaque industry concentrated in a small number of hands. 

With Tesla turning to Chileto secure the lithium it needs to power mass production of electric cars, and SQM and Albemarle doubling capacity, it is critical that the government of Chile strengthen its monitoring of the industry to ensure the country gets a reasonable return from its valuable resources. 

A “withhold up” in Mongolia?


Thoughts on the renewed tax debate around Oyu Tolgoi  

Co-authored with David Mihalyi. Cross-posted from International Centre for Tax and Development

Located in the Southern Gobi region of Mongolia, Oyu Tolgoi is one of the world’s largest copper and gold deposits. The Oyu Tolgoi mine (OT) is jointly owned by the government of Mongolia (34 percent) and Turquoise Hill Resources (66 percent). The latter is a Canadian subsidiary of Rio Tinto listed on the Toronto and New York Stock Exchanges. The OT project combines an open pit and an underground mine that produces copper concentrate, which is then transported by rail to China for processing.

Since OT began in 2010, construction of the mine has cost USD 11 billion in capital expenditure. Phase 1 was the construction of the open pit mine (which was financed by shareholder debt from Rio Tinto) and Phase 2 is the construction of the underground mine, which is being funded by external project finance. From the outset, Rio Tinto has “carried” the government of Mongolia’s (GoM) 34 percent equity interest in OT, meaning it pays the GoM’s upfront financial contribution, which will be paid back via the GoM’s share of dividends.

In a report issued by the Centre for Research on Multinational Corporations (SOMO) in February, Rio Tinto was accused of minimizing its tax obligations in Mongolia by 1) “illegitimately lowering” its withholding taxes (WHT) on interest paid on foreign loans by $232 million; and 2) financing its Mongolian subsidiary via loans routed through entities in the Netherlands and Luxembourg—which offer double taxation agreements with Mongolia, as well as lower tax rates. The report also alleges that in addition to the WHT issues in Mongolia, Rio skipped out on $559 million in corporate income tax in Canada (this issue won’t be considered here).

Though an evaluation of the deal is beyond the scope of this piece, and would necessarily start from detailed modeling of all revenues throughout the life of the mine (such as what is done by OpenOil), there are important policy lessons to draw from this case and the revenues that have so far been collected.

WHT requires the taxpayer to withhold some income tax on payments made abroad. For example, let’s say a taxpayer in Country A borrows $1,000 from a lender in Country B. The lender requires 10 percent interest on the loan ($100). The WHT rate in Country A is 5 percent, meaning the borrower must withhold $5 WHT on the $100 interest it pays to the lender. WHT is usually levied on service charges, shareholder dividends and interest expense on foreign loans. We focus on the last category.

WHT on interest is important for three reasons. First, it can be a significant source of revenue for governments—particularly given the level of capital investment (and hence financing) required in the mining sector. Secondly, it is comparatively easy to collect, which is critical in countries with weak tax administration. Finally, and perhaps most importantly, WHT is a safeguard against tax base erosion and profit shifting (BEPS).

The implications of the $232 million foregone in WHT will be discussed in light of these reasons:


 a)     Significance of the WHT concession

Between 2011 and 2015, Rio took advantage of a lower rate of WHT in a double tax agreement (DTA) between the GoM and the Netherlands. Amongst other tax concessions, the treaty stipulated a WHT rate of 10 percent on interest, reduced from the 20 percent that is required by Mongolian law. The result was what SOMO estimates to be $173 million in forgone tax revenue so far (i.e., the difference between 20 percent and 10 percent WHT). Rio Tinto’s own taxes-paid reports show that despite its lowered rate, WHT on interest has been a major source of early revenues (providing, for example, more than a third of the $149 million in total taxes paid in 2016 to the GoM). OpenOil’s financial model estimates that a lower rate (a reduction from 20 percent to 10 percent on Rio’s share) of WHT on interest will cost the GoM $700 million in potential tax revenue over life-of-mine.

While the lower rate of WHT on interest payments has had a material impact on GoM revenues, it does not seem that Rio Tinto specifically structured the deal in a way that would benefit from a lower WHT per the DTA with the Netherlands. In the period reviewed by SOMO, 100 percent of OT’s debt was funded by shareholder loans, which attracts a rate of 10 percent WHT under the Netherlands DTA. This rate is equal to the rate Mongolia has in tax treaties with a range of countries, including in Canada (see Table 1 below), so Rio did not need to “treaty shop” for this particular benefit. Furthermore, the rate is also consistent with global treaty practice (Art.11 of the OECD Model Convention) and the International Monetary Fund had pointed out the potential risk to revenue in 2008, a year before the GoM signed the investment agreement with Rio Tinto. Therefore, the GoM should have been aware of it.

However, one aspect of the Netherlands DTA that is unique—and could give rise to claims of treaty shopping—is the lower rate of 0 percent WHT for interest paid on loans from financial institutions. The WHT distinction between financial institutions and other lenders creates a risk of “back-to-back loans”, whereby a third party (e.g., a foreign bank) is interposed between two related taxpayers (such as a foreign parent corporation and its subsidiary) to avoid the higher rate of WHT that would apply if a loan were made directly between the two taxpayers. As far as we know, Rio has not availed itself of this opportunity. The $4.4 billion project financing agreement for phase 2—which is funded by a mix of international financial institutions, export credit agencies and commercial banks—is directly with the OT Mongolian subsidiary, and consequently the Dutch treaty does not apply. Notwithstanding, the GoM should closely monitor any future bank loans originating from the Netherlands.

Another grave concern (raised but not discussed in detail by SOMO) is that the Dutch treaty also lowered the WHT on dividends to zero, which is below the rates seen in Mongolia’s other treaties and in the OECD Model Convention. This may have an important impact on future revenues, though it needs to be assessed in light of the deal as a whole.

Table 1. Withholding taxes on interests and dividends

Screenshot 2018-03-22 17.30.43.png

Sources: Domestic rates, Canadian Treaty rates, Dutch Treaty rates and OECD convention rates.

Recognizing the risk to revenue, the GoM annulled the Dutch treaty in 2014. However, the lower rate continued to apply because of the fiscal stabilization provisions in Rio’s Investment Agreement. Fiscal stabilization assurances are where a government commits to either partially or completely fixing the fiscal regime. This is to avoid a situation where governments offer favorable terms but reverse them as soon as investment is completed. Though it is best practice to limit the duration and scope of stabilization provisions, it is not uncommon to fix key tax terms for such large deals in the mining sector, especially in uncertain legal and political environments. The investment agreement is carefully drafted to include Mongolia’s double tax agreements in the stabilization mechanism.


b)     Tax administration: not all taxes are created equal

WHT on interest is relatively easy to collect, and therefore less likely to involve significant financial and human resources, or result in taxpayer disputes. This is particularly important given Rio’s complex corporate structure and funding arrangements for the mine have been a source of tension for many years. GoM issued Rio a $130 million tax claim in 2015, which was later reduced to $31 million after discussion at the Dispute Resolution Council of the Mongolian Tax Authority. Earlier this year, the GoM issued a $155 million tax claim against Rio - an extensive audit is expected to follow. Both cases demonstrate some of the difficulties in collecting various other taxes.

Despite WHT on interest being an easy tax to levy, SOMO revealed a newer WHT concession, which, it alleges, further reduces GoM revenues by $59 million. The concession relates to Rio using an even lower rate of WHT on interest, 6.6%. The basis for the lower rate is Article 18(c) of the Amended and Restated Shareholder Agreement (ARSHA) (2011). The Article states that Erdenes OT (the state-owned company that manages GoM’s investment) is responsible for all taxes attributable to its 34% share, including for the repayment of interest on loans obtained from shareholders. Rio and Erdenes OT therefore owe 66% and 34% respectively of the WHT amount for total interest expense on shareholder debt. In practice this meant that Rio was effectively paying a WHT rate of 6.6% (i.e. 10% of 66%) on OT’s total interest expense on shareholder debt. The OT Netherlands 2015 company report (not in the public domain, obtained by SOMO) references a letter from the GoM, which confirms this assessment.

While it seems reasonable that over the long-run Rio Tinto should not have to pay the taxes attributable to the Erdenes OT share of the debt, in the short term, an alternative would have been to pay the 10% WHT, add it to the GoM’s tab for later repayment via dividends, thus leading to higher tax receipts now.

It is important to evaluate the WHT on interest concession against other characteristics of the deal, we don’t do this in detail here, but others have. For example, unlike many other mining countries, in Mongolia, the Value Added Tax (VAT) charged on mining inputs is actually a tax (i.e. non-refundable). Consequently, VAT is an important, and unique, early source of revenue for the GoM. On the other hand, Rio also got an investment tax credit, which means it can offset some of its capital expenditure against its income tax charges. The significance of the reduced WHT rates need to be seen (and modelled) in light of all these other terms, and also taking into account when the deal was done.


c)     A safeguard against profit shifting

Companies can finance a mining investment through debt or equity. Debt is treated differently to equity for tax purposes: interest payment on the debt can be deducted from taxable income, reducing a company’s overall tax bill. Consequently, companies have an incentive to increase their leverage (i.e., increase the proportion of debt in their sources of financing), in particular for subsidiaries in high-tax countries. WHT on interest is also a financial barrier to such practices - a ‘last line of defence’.

SOMO is right to be suspicious of  the reduced WHT on interest, and Rio’s financing of its Mongolian subsidiary via loans routed through entities in the Netherlands and Luxembourg (countries well known for channelling tax avoidance). Intercompany loans regularly create opportunities for multinational groups to shift profit from high-tax to low-tax jurisdictions via excessive interest deductions (see the recent Chevron case in Australia). However, the critical question is whether the rate paid by the Mongolian subsidiary differs significantly from the other participants.

Luckily, the SOMO report sheds some light on previously unseen financial accounts from the Dutch subsidiary, which we can tentatively analyze. A back of the envelope calculation, suggests that the Rio subsidiaries in Luxembourg, the Netherlands, and Mongolia are all using interest rates of approximately LIBOR +5.5%-5.6%. Had there been large differences between the different subsidiaries this may have been a smoking gun for profit shifting, but the little information we have does not indicate that Rio was stripping profit out of the mine via interest expense. In any event, if the GoM wants to find out if the interest rate the Mongolian subsidiary is paying is reasonable it has two benchmarks – 1) the project finance at LIBOR +6% (bearing in mind this rate is likely to have been ‘grossed up’ somewhat to account for the WHT payable by the international banking syndicate), and 2) the 2015 financing and guarantees obtained from the International Finance Corporation.

While Rio’s complex financing structure may not be the culprit, there is another profit shifting risk the SOMO report does not address. That is, the management service payments (MSPs), which are 3% of the total capital and operating cost of the mine up pre-production, and 6% thereafter. Management services are where a subsidiary pays a fee to a related party in return for a range of administrative, technical and advisory services. In this case, OT pays Rio Tinto a fee, via its subsidiary in the Netherlands, for providing mining expertise and technical services, procurement and logistics, risk and compliance, commercial services and human resources services. The ‘mischief’ is the way the fee is calculated based on the total capital and operating cost of the mine, rather than the actual cost of providing the service, plus a small mark-up, as recommended by the OECD Base Erosion and Profit Shifting (BEPS) project Action Items 8-10.

The argument against using “cost-plus” is the time and effort it would take Rio to accurately allocate costs, and the Mongolian Tax Authority to verify. That may be so, but arguably a more prudent route would have been for Rio to request an advanced tax ruling to agree on the cost allocation method, and mark-up. Rio has shown willingness to enter similar agreements in Australia, Canada, and Singapore, albeit via Advance Pricing Agreements, which are legally binding.

OpenOil estimates that MSPs add up to $2.9bn in real terms in Rio’s 2014 Technical Report. The planned $5.3 billion expansion of OT will swell MSPs even further, significantly reducing the Mongolian subsidiary’s taxable income, and further deferring the GoM’s dividends. Ideally, Rio and the GoM would agree an alternative way to calculate MSPs that better reflects the cost of the service, and set a limit on MSPs relative to total costs.



SOMO uncovered important new information from company fillings of the OT project. The lack of clarity on applicable WHT rates is a cause for concern; therefore, it would be beneficial if GoM and OT produced a joint communique on which WHT rates apply for the shareholder loan, the project finance loan, and future dividends. However, it would be an exaggeration to conclude that Rio avoided WHT on interest on shareholder loans, and there is no clear evidence of excessive interest deductions to support the claims of treaty abuse. Nevertheless, moving forward, the 0% rate of WHT in the stabilized Dutch treaty on bank loan interests and dividends, more favourable than other DTAs, may be an issue.

The revealed costs in early and easily collectable WHT revenues provide an important lesson on the dangers of (stabilized) tax treaties. But, it is critical that any tax concession and dispute are viewed in context against the deal as-a-whole, looking at both the costs and the benefits that flow from the mine. 

New Toolkit Aims to Curb Transfer Mispricing in African Mining

Cross-posted from ATAF blog.

38 African tax authorities have, this week, converged in Abuja for the International Conference on Tax in Africa, convened by the African Tax Administration Forum (ATAF). The group is discussing ways to boost tax revenues, in particular, how to improve collection of corporate income tax.

His Excellency Professor Yemi Osinbanjo, Vice President of Nigeria said in his keynote address, “the use of aggressive and suspicious tax planning and transfer mispricing by multinationals to minimize their tax payments” is a major constraint to domestic revenue mobilisation in African countries.

Increased multinational investment in Africa over the past decades has boosted the risk of transfer mispricing, which occurs when two related parties distort the price of a good or service to reduce their taxable income. 

As a result, the regulatory environment in Africa around the phenomenon is quickly evolving.

Between 1995 and 2014, the number of African countries with transfer pricing rules has grown by 600 percent, according to Ernst & Young. They are developing standalone transfer pricing regulations; building specific expertise; setting up specialized transfer pricing units; and working together to share best practices through ATAF.

However, evidence shows that few African tax authorities have the sector-specific expertise to detect and mitigate transfer mispricing in the mining sector. Many tax authorities don’t have close knowledge of the mining sector, which hinders their ability to distinguish between abusive versus standard industry practice. Risk assessment is critical for developing country tax authorities given the limited resources they have to audit taxpayers.

To combat this problem, ATAF, and Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH, on behalf of the German Federal Ministry for Economic Cooperation and Development (BMZ), have today, at the International Conference on Tax in Africa, released the Toolkit for Transfer Pricing Risk Assessment for the African Mining Industry. The toolkit is the first of its kind addressing mining. It aims to assist African tax authorities to determine whether particular high-risk related party transactions should be selected for transfer pricing audit. The toolkit is complementary to and supplements the ATAF Transfer Pricing Risk Assessment Tool, which applies to all sectors.

The toolkit is practical. Tax authorities can immediately integrate it into existing transfer pricing compliance processes. It can be used in any country context and adapted for legal differences. Authorities can identify and assess transfer pricing risks in the mining sector, select the most high-risk cases for audit, and protect the mining tax base against profit shifting.

The toolkit addresses for instance the use of offshore marketing hubs: cases where a mine sells its product to a related company that then on-sells to a final customer. The risk is that the marketing hub pays an artificially low price to the mine, reducing profits in the host country, and sells the product onto a third party at market rate, allowing profits to accumulate with the hub, often in a low-tax jurisdiction. These transactions can represent big losses for resource-rich countries. BHP Billiton is currently in a dispute with the Australian Tax Office (ATO) over a USD 755 million tax bill relating to its use of a marketing hub based in Singapore to sell commodities to Asia.

How would a tax authority use the toolkit? Let’s assume the authority is planning a general audit of a large mining company. It is deciding whether the issue of a related party loan should be included in the audit. The tax authority uses the toolkit as a basis for reviewing the terms and conditions of the loan. It spots that the loan lacks a fixed repayment period, as well as financial and non-financial conditions. According to the toolkit, the absence of a clear obligation to repay may indicate that the loan is not arm’s length. Consequently, the authority decides that there is a sufficiently high risk of transfer mispricing to warrant an audit.

In addition to the toolkit, which can be downloaded here, tax authorities can receive training on how to use it. The Intergovernmental Forum on Mining (IGF) is the official training partner for the toolkit. Interested parties should contact me at or GIZ’s Anna Kravtsenko at

Alexandra Readhead is the author of the toolkit.

Inflated Expectations about Mineral Export Misinvoicing are Having Real Consequences in Tanzania

Cross-posted from the Center for Global Development. Co-authored with Maya Forstater.

At the Buzwagi and Bulyanhulu gold mines in Tanzania, and at the Port of Dar Es Salaam, around a thousand containers of copper-gold concentrate (a processed product between rock and refined metal) are stockpiling. They belong to Acacia Mining PLC, who operate the two mines, and are not moving because of a ban on concentrate exports that has been in place since the beginning of March.

In May, President Magufuli appointed two special committees to investigate the contents of 277 of the containers stuck at the port. The first committee reported that the concentrate contained around twice as much copper and silver, and eight times as much gold than was declared by the company (the main value of the concentrate comes from gold). They also detected a range of rare earths. According to their calculations, each container contains 28 kg of gold and is worth $1.36 million while information published by Acacia suggests that each container contains 3.3 kg of gold, 2.8 tonnes of copper, and 2.6 kg of silver and is each worth around $0.15 million. If the committees’ findings are accurate, the extent of the undervaluation would be enormous, amounting to almost $4 billion annually (one tenth of Tanzania’s GDP). The second committee scaled these figures up to cover 61,320 containers exported between 1998 and 2017, suggesting the true value of concentrate exports was $83 billion and that the government had lost $31 billion of revenue trade due to misinvoicing and transfer price manipulation. Acacia maintain that they have always declared all materials produced and paid all royalties and taxes that are due. 

Credit: Maya Forstater (co-author), based on data from Mruma Committee Report and Acacia/SGS information

President Magufuli responded to the committees’ reports:

We should summon them and demand that they pay us back our money. If they accept that they stole from us and seek forgiveness in front of God and the angels and all Tanzanians and enter into negotiations, we are ready to do business.

The business in question is the demand that Acacia build a local smelting facility (the government’s stated aim for the ban on concentrate exports). In 2011, The Tanzania Minerals Audit Agency examined the viability of a smelter and concluded that it would not be profitable given the volumes and quality of concentrate involved. If the concentrate produced by the mines turned out to contain eight times more gold than previously thought, these calculations might look different.

However, the committee’s belief that they have uncovered a case of massive misinvoicing (i.e., misrepresentation of the value or quantity of exports) does not seem plausible for five reasons:

1.    The findings suggest a massive scale of hidden metals production.

The committee’s reports say that the 277 containers (which represent around one month’s production) contain around 7.8 tons of gold. This is roughly equivalent to the total amount of gold Acacia reports that these two mines produce in a year. Acacia note that the committee’s findings on the amount of Iridium in the concentrate (16.9 tonnes annually), would be nearly three times global consumption of the metal. The findings for Ytterbium (9.8 tonnes annually), would be on par with largest producer in the world.

2.    These findings are geologically implausible.

Acacia notes that the results imply that they produce (from Acacia’s three mines in Tanzania) more than AngloGold Ashanti produce from 19 mines, Goldcorp from 11 mines, and Kinross from 9 mines, and that this is implausible given the size of the mines. They also argue that economic Iridium concentrations are only found as by-products in certain types of mines, not in gold deposits of the type found at Bulyanhulu and Buzwagi, and similarly, that significant levels of rare earth elements such as Ytterbium are not found in this kind of deposit.

3.    The committee’s analyses suggest an extraordinary conspiracy has undermined Tanzania’s efforts at monitoring minerals exports, as well as international financial regulations.

The Tanzania Mineral Audit Agency (TMAA) undertakes careful work to monitor minerals exports. Normally four samples are taken from every shipping container—one for Acacia (which is verified by SGS), one for the TMAA, one for the smelting company, and an umpire sample in case of disputes. Furthermore, Acacia is a FTSE250 company; it must comply with international regulatory agencies in the UK, Canada, and the United States, which require the company’s financial statements and figures to be audited in accordance with international standards. For Acacia to under-report its gold production and revenues would mean defrauding shareholders through an enormous global conspiracy.

4.    The committee’s approach to pricing the concentrate does not reflect how the metals industry works.

The committees calculated a value for every element including trace elements such as tantalum, beryllium, and ytterbium, and bulk ones such as sulphur. However, smelters do not pay out for every element in the material, but only the ones they contract for, since the rest end up in the waste pile or eventually as “anode slime” by-products at the end of the copper refining process. Acacia say they are only paid for copper, silver, and gold (and MRI Group which buys the concentrate from them confirm this).

5.    There is no sign of an additional $4 billion a year of unexplained sales in Acacia’s accounts.

Acacia’s shareholders, who have some skin-in-the-game to know what is going on, are not reacting like they have just found out that the company’s management have been defrauding them, nor that the company owns assets which are worth several times more than they thought.

While the committees’ findings are hard to believe, this doesn’t necessarily mean government isn’t justified in its concern that Acacia has not been paying enough tax. Between 2010 and 2015, Acacia paid $444 million in dividends to shareholders, despite not yet paying any income tax in Tanzania. OpenOil explains that generous fiscal terms are the primary cause, specifically, an additional capital allowance meant Acacia could deduct 100 percent of its $4 billion investment, plus a 15 percent margin, before paying any income tax.

$252 million was a “special” dividend following an initial public offering (IPO)—in other words, these funds went from new shareholders to Barrick Gold, not from the Tanzanian subsidiaries to all shareholders. However, the question of how profits to pay the rest of the dividend were available in London has never fully been answered. One possibility is that Acacia is engaging in “base erosion and profit shifting” via its Group Finance Company in Barbados. Acacia may be raising equity, and, through the Group Finance Company, providing it as intercompany loans to its Tanzanian subsidiaries. Because interest payment on the debt can be deducted from taxable income, the more debt the mines have the less taxable income they generate. Plus, interest payments are a way of shifting profits earned in Tanzania, to the Group Finance Company in Barbados. This practice of “earnings stripping,” could explain how Acacia financed the dividends. But, without access to disaggregated data for finance charges, it is not possible to know whether this theory is correct.

In Tanzania, there is significant risk attached to challenging the committees’ findings. The Minister of Mines and the chief of the TMAA were both fired following the first committee’s report, and a weekly magazine was ordered to shut down for two years after publishing an article questioning the role of previous presidents in negotiating the original mining agreements. The “Publish What You Pay” coalition of NGOs working on extractive industry transparency report has issued a general statement, but has not offered any analysis, while the Tanzania Extractive Industry Transparency Initiative has made no public statement.

It is not clear that compelling Acacia to build a smelter would be a win for Tanzania. Thomas Scurfield at NRGI warns that it would distract government attention and power supplies from other areas of the economy and might result in lower government revenues, not higher, if the marginal increase in export value it generates is offset by higher costs. Without balanced coverage of the issues related to revenues, and the economic prospects for smelting, Tanzania may end up worse off. To date, media coverage of the situation has been unbalanced, and potentially misleading.

Securing mining revenues is a major challenge for Tanzania, as with other resource-rich developing countries. Often governments know something is wrong, but lack the information, resources, and expertise to pinpoint the precise cause. However, it is vital that public debate is informed and critical, and that simplistic narratives portraying multinational mining companies as undertaking massive ‘illicit financial flows’ through widespread mispricing of ores and metals are not accepted without evidence. Governments should also avoid this trap at risk of raising public expectations of mining revenues to unsustainable levels.

Acacia and the government are now sitting down to talks with the hope of reaching a “win-win” solution. Finding a way to unwind inflated expectations, build trust and effective, realistic public scrutiny will be critical to finding a solution which is not just win-win for the president and Acacia but also for the people of Tanzania.

Is Indonesia’s move to “gross-split” the future of oil and gas production sharing arrangements?

Over the last decade, the Government of Indonesia has become increasingly concerned that petroleum companies operating the country’s oil and gas fields have been inflating costs through overspending. In 2016, a report by the Supreme Audit Agency (BPK), revealed that several petroleum companies (“contractors”) had inflated the reimbursement of their operating claims by US$300 million.

Production sharing contracts (PSCs) are common in the petroleum sector. Roughly two-thirds of petroleum producing countries have this as the core component of their fiscal regime. Under a PSC, the contractor is entitled to take a share of total production to cover its exploration and development costs (“cost oil”), and what’s left is then split between the contractor and the government (“profit oil”) according to some formula set out in the PSC. This mechanism for apportioning production is called “cost recovery.” While countries may vary the ratio of cost oil to profit oil, cost recovery has, until now, been the defining feature of the PSC.

In January this year, the Government of Indonesia abandoned the cost recovery approach. In its place the Government will apply a “gross-split” method, apportioning production solely based on a percentage, leaving all capital and operating costs to be borne by the contractor. This specific policy is virtually unknown in the world of upstream oil and gas contracts (Peru used it briefly in the 1970s). However, it is not too different from a royalty/ tax regime, whereby the contractor pays a combination of (1) a royalty based on the volume, or value of oil extracted, (2) income tax, and (3) a resource rent tax to capture a larger share of profits of the most profitable projects. Under gross-split, the contractor is effectively ‘paying’ a royalty by handing over a share of production to government before recovering its costs. This is attractive because government can collect revenue as soon as production commences. However, there is still a risk that contractors will inflate cost claims applied to income tax computations.

The Government of Indonesia argues that under cost recovery, contractors are incentivised to inflate costs to increase their share of production, the result being that Government’s share is reduced. By moving to a gross-split, contractors are forced to shoulder the costs themselves, which Government expects will encourage them to operate more efficiently, and protect the State budget. Under cost recovery, all expenses had to be pre-approved by the oil and gas regulator, SKK Migas, which led to significant delays for contractors. By giving contractors more freedom with respect to procurement and technology, the Government hopes to create a more attractive environment for investment.

Indonesia’s move away from cost recovery has been a long time coming. It is an issue that has become increasingly politicized, with the public regarding it as unfair that contractors’ costs reduce the Government’s share of production by hundreds of billions of dollars every year. It’s not hard to see why, when in 2016, the cost of cost recovery reached $13.9 billion, which was more than the sector raised in non-tax revenues. There are also administrative challenges involved in applying cost recovery. According to the Deputy Energy Minister, Arcandra Tahar “the problem with cost recovery is, there have been endless debates between SKK Migas and contractors as to how much exactly the production costs should be. It’s not easy to calculate technology costs, especially in cases where only one company has a particular technology.” SKK Migas has 750 staff; roughly 80% are involved in administering cost recovery.

Gross-split will increase the Government’s take from the sector, and ease administration. However, it may also deter investment, and prevent Government from capturing the upside if oil prices end up rising. Under the proposed gross-split of 57:43 (in favour of Government), contractors’ Internal Rate of Return (IRR) will be reduced by approximately 6% on average across all exploration prospects (i.e. onshore and offshore). The big test will be the bid round currently underway. WoodMackenzie, and company executives, are doubtful there will be much interest under the gross-split model. If they are right, Government may be forced to recalibrate the split to something that more closely resembles contractors current IRR. Given the political significance of the issue, we’re unlikely to see Government do a U-turn on gross-split.

Indonesia is not the only petroleum producing country to struggle with cost recovery risks. Tanzania’s former upstream regulator, the Tanzania Petroleum Development Corporation (TPDC), has expressed concern about companies inflating drilling rig rental fees. According to them, Tanzania’s status as a frontier basin makes it easy for companies to record the maximum rental price, and the TPDC lacks the appropriate benchmarks to challenge these cost claims. The challenge of auditing cost claims does not disappear with the gross-split model, but at least it is contained to calculating income tax, rather than being allowed to erode government’s share of production as well.

There is merit to supporting resource-rich countries to strengthen cost recovery audits. But with finite audit resources, and limited benchmarks to evaluate cost claims, Indonesia’s response to move away from cost recovery as a basis for production sharing may prove a more pragmatic approach. Petroleum producing countries will be watching closely over the next few months to see if Indonesia can get the balance right between maximising economic benefit from oil and gas, whilst continuing to encourage investment. If the Indonesians can achieve this, gross-split may well be the future of production sharing in oil and gas.

Securing Mining Revenues: Good Practice from Zambia, Tanzania, and South Africa

Co-authored by Thomas Lassourd. Cross-posted from NRGI

In Sierra Leone, the tax authority’s total budget allocation for 2015-16 was USD 13 million, about 0.5 percent of Australia’s. It has six staff responsible for auditing extractive industry taxpayers in a country where, pre-Ebola pandemic, roughly 20 percent of gross domestic product was a result of mining. None of the staff are transfer pricing specialists, and Sierra Leone’s tax court was only set up in 2015.

“We do not have capacity to get involved with legal issues,” the deputy minister of mines said. “Companies have the best lawyers; as a ministry we don’t have the best lawyers.”

Faced with such limitations, what lessons can Sierra Leone learn from countries like South Africa, Zambia, and Tanzania, which are finding context-relevant and innovative ways to limit the ability of foreign multinationals to avoid paying taxes?

NRGI’s regional report on preventing tax base erosion showed that many mineral-rich countries in Africa face similar challenges in applying “global standards” led by the Organisation for Economic Co-operation and Development to stop multinationals from using cross-border transactions to avoid tax. In particular, tax authorities struggle to apply the arm’s length principle, which compares the price of a transaction between related parties with the price of similar transactions carried out between independent parties. This is because accessing appropriate comparable data is so challenging.

NRGI is publishing case studies on South AfricaTanzania and Zambia that describe alternative legal and institutional mechanisms that these countries have put in place to control the price of mineral exports, operational and capital expenditures, and the cost of debt.

South Africa is one of the first countries in the world to introduce a law to limit the deduction of interest payments to foreign-related parties. Deductions that exceed 40 percent of turnover are disallowed. This hard cut-off means the South African Revenue Service can protect the tax base without getting into the nitty-gritty of pricing loans. (As this recent Chevron case in Australia shows, pricing loans is extremely difficult.) Action 4 of the OECD Base Erosion and Profit Shifting (BEPS) project has adopted a similar approach, while recommending a higher cap between 10 percent and 30 percent of turnover.

In Zambia, taxes from the mining sector have disappointed the public, particularly as copper prices hit historic highs. Civil society organizations believed that mining companies were selling their copper to foreign related parties under market rate to pay less tax in Zambia and accumulate profits offshore. In response, Zambia adopted an additional transfer pricing method that requires mining taxpayers to use publicly quoted benchmark prices—for example, from the London Metals Exchange—to calculate all mineral sales to related buyers. The rule makes it harder for companies to distort their mineral sale price to avoid tax.

“It removes a free kick for companies,” says one Zambian tax official.

The government of Tanzania has recognized that tax officials alone cannot detect and mitigate tax avoidance by mining multinationals. They need support from mining industry experts. The Tanzania Mineral Audit Agency (TMAA), set up in 2009, is responsible for monitoring the quality and quantity of mineral exports and the financial performance of mining companies. TMAA’s efforts have helped the tax authority collect USD 64.8 million in additional corporate tax, accounting for roughly 7 percent of mining tax receipts between 2009 and 2015 and twice the TMAA’s budget over that period.

South Africa, Zambia, and Tanzania have decided that they do not have the resources to audit all of the transfer pricing practices of multinational companies. They have therefore tried to avoid getting into unwinnable battles by introducing clear, objectively verifiable and easy to administer tax rules, as well as strong government institutions to oversee the mining sector. Other mineral-rich countries should take note.

Reputable Mining Investors Wanted in Sierra Leone: How to Improve Due Diligence in Mining License Management

Gravel waste from the mine towers over Koidu in eastern Sierra Leone. Photo: Cooper Inveen / GroundTruth

Gravel waste from the mine towers over Koidu in eastern Sierra Leone. Photo: Cooper Inveen / GroundTruth

On the first anniversary of the Panama Papers, the National Minerals Agency (NMA) of Sierra Leone wants to know who it is doing business with. The NMA is the government agency responsible for issuing mining licenses. Beny Steinmetz of Simandou fame, is one such mining investor who has prompted the NMA to strengthen integrity due diligence. The Panama Papers implicated Steinmetz in a complex chain of ownership of Koidu Holdings, Sierra Leone’s largest diamond mine. By checking the reputation and track record of applicants, the NMA hopes to weed out shady investors, and instead attract reputable companies to transform Sierra Leone’s mineral wealth. This ambition is echoed by the EITI’s call for disclosure of the ultimate owners of extractive companies, as well as the launch of a global beneficial ownership register by OpenOwnership.

But, is it realistic to expect a resource constrained country such as Sierra Leone to be able to reliably test the ‘integrity’ of mining investors?

The short answer is yes. From October 2016 to March 2017, I was contracted by OpenOil to work the NMA to strengthen integrity due diligence in mining license management. The project was funded by the Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH. We found that prioritisation of resources, smart use of commercial products, and the ability to judge risk, enable the NMA to build a reasonably comprehensive picture of the integrity (or not) of potential investors. The expectation should not be that the NMA will always uncover the ultimate owner, or chase down the last dollar. The goal is to make informed decisions about who gets access to Sierra Leone’s natural resources.

Here are four lessons we learned that may be useful to other countries:


1. Prioritise mining license holders for ongoing integrity checks.

Developing country governments may not have enough staff to run integrity checks on all mining license holders. The NMA has four compliance staff to oversee 175 industrial mining licenses, and 2,078 trading licenses. Thankfully, not all license holders pose the same level of risk to the sector, or the wider economy. With the NMA, we developed a way of ‘triaging’ high-risk license holders for regular integrity checks. Regular checks are important because the business profile of a license holder may change over time (e.g. sale of asset).

Here’s what we did:

  1. First, we identified a set of risk indicators to measure all license holders against, based on data the NMA already collects via its Mining Cadastre System (e.g. contribution to total non-tax mining revenue);
  2. We gave each indicator a weight based on level of risk, and reliability. For example, variation in sale price has been given less weight than presence in a low-tax jurisdiction. This is because there may be numerous legitimate reasons why a company’s sale price would be lower than the market price (e.g. differences in quality), making this indicator less highly correlated to risk;
  3. Finally, we proposed an algorithm and scoring system for each indicator. The NMA is currently embedding these rules into its data analytics system. The result will be an automated list of 10-12 ‘watch list’ companies that require ongoing monitoring by NMA compliance staff.

Our aim was to establish an automated system that can generate a reasonable assessment of whether an existing mining license holder should be subject to ongoing integrity checks. Where the results appear incorrect, NMA staff can add or subtract ‘watch list’ companies.

Integrity Due Diligence Risk Matrix

2.   Commercial databases must be evaluated based on their specific application to the mining industry in the source country.

There may be limits to what open source data can deduce about an investor (e.g. where an investor is wholly owned by a company in a financial secrecy jurisdiction). The response to this challenge is usually that countries should invest in a commercial database from Reuters, or Bureau Van Djik. Yet, for many developing countries, including Sierra Leone, the cost of a database (anywhere from £5000 to £25,000 per year) is hard to justify. To decide whether to invest in a subscription, government agencies should test the specific application of the database, to the mining industry in their country. In doing so, they should consider the following issues:

  • The volume of mining companies that need monitoring. It may be that government would use only a fraction of the information on the database, despite paying for the whole resource;
  • How much information the database contains on privately held companies, that is not publicly available from the local registry. The main reason to subscribe to a database is to aid due diligence of privately held companies. Yet, if the database is so scant that government would need to purchase extra data elsewhere (e.g. from a consultancy), it may not be a good investment;
  • The extent to which the database uses public information to identify Politically Exposed Persons. It may be that this information comes from media and news websites, company websites, and sanctions lists, all of which are publicly available;
  • If the mining regulatory agency can establish the corporate ownership structure of mining investors i.e. identify all legal entities, directors, officers, shareholders etc. Some databases rely on users first knowing who the legal entities, and individuals involved are, to be able to search them. Developing countries should avoid databases that need a high level of prior knowledge of corporate structures.

A commercial database might be feasible if the EITI Secretariat and donor partners were to buy a collective subscription to license out to EITI implementing countries. This would be more cost effective, as well as help countries to implement the EITI standard on beneficial ownership.


3.   Countries with a small number of mining investors may find purchasing one-off due diligence reports more cost effective than subscribing to a database.

If a government agency finds closed data necessary to conduct due diligence, a more cost effective and targeted solution is to buy one-off due diligence reports for specific mining license applicants. However, there are costs involved with this approach, therefore it should only be done for high-risk privately held companies (e.g. investors linked to State Owned Enterprises), once the compliance team has exhausted all possible means of researching the company. An advantage to this approach is that it ‘kills two birds with one stone’ by getting a report, as well as translation of local registry documents and media.

Depending on the level of reporting, standard reports range between £100-£800. Very sophisticated reports can go up to $30,000. The cost comes down to how much source commentary, or ‘on-the-ground’ investigation is involved. In most cases, a standard due diligence report (company registration, adverse media results, sanctions and enforcements, basic information on directors and shareholders) should be enough for integrity checks, unless there are very serious concerns, or challenges to accessing company records.

For a country like Sierra Leone, where there is a handful of significant mining operations, buying one-off reports is undoubtedly more cost effective than subscribing to a database. This may not be the case for other countries with a more developed mining industry. However, even these countries may find it strategic to purchase one-off reports given databases can be variable on privately held companies.


4.   Countries seeking disclosure of ultimate owners require a legal framework for beneficial ownership. In the meantime, governments can use other data to inform integrity due diligence.

Whilst the NMA has ambitions to know who the ultimate owners of companies are, as it stands, the law only requires disclosure of shareholders who own 5% or more of the issued share capital. There is a legal review currently taking place, which will likely result in comprehensive beneficial ownership legislation. However, integrity due diligence does not have to wait until legal reform takes place. A lot can be deduced from information already collected by government agencies. For example, the NMA can already detect some PEPs issues based on the shareholder and related party data it collects from license applicants. Bearing in mind their current legal framework, government agencies should update existing disclosure requirements to maximise the due diligence relevant information they are already entitled to.

* * *

Effective due diligence of investors is critical to countering corruption, tax abuse, and criminal activity in the mining sector. Due diligence solutions should be simple and cost effective, considering the resources and capabilities of the government agency responsible for administering them. The mark of success is not a government agency knowing every legal and natural person involved in an investment. But, whether that agency can put forward an informed and reasoned view of the level of risk associated with an investor, such that a decision to grant a license (or not) can be made, and areas of concern flagged for ongoing monitoring. 

Alexandra Readhead was the OpenOil Team Leader for the NMA due diligence project. 


Treasuries in Africa Mining Hubs Under Pressure

Note: this blog originally appeared as an op-ed in This is Africa on 6 July 2016

When the African Union’s members meet in Kigali, Rwanda, from 10 to 18 July, the dire state of their public finances will likely be a key topic.

The bust in mineral and oil prices has left many resource producers with budget shortfalls. The cuts in public spending that are likely to ensue threaten social spending and development plans. With USD 35bn worth of Eurobond debt maturing between 2021 and 2025, African mineral producers have only a few years to right the ship.

Data visualization by Giorgia Ceccinato for NRGI

As finance ministers weigh options to balance their budgets, they will want to ensure that taxpayers pay their due. But this is easier said than done. Tax administration in many countries is weak, and tax policies suboptimal.

This leaves governments vulnerable to maneuvering by multinational companies – in the mining sector in particular – whose complex corporate structures allow them to make the most of the many loopholes and peculiarities of the global tax system.

Mining structures

Subsidiaries of global mining companies in Africa mostly trade with companies with which they are affiliated. They sell mineral production to marketing centers, finance the development of a mine’s infrastructure, buy machinery or pay for legal and accounting services.

If miners did this business with unaffiliated companies, they would negotiate deals for goods and services at market prices. But because most of these transactions are between affiliated companies, deals take place at “transfer prices” set by tax accountants, legal experts and management controllers at the global level to maximize a multinational company’s profits.

This can run counter to the host country’s interests when the transacting affiliates undervalue sales or overvalue purchases to reduce the declared profits – and subsequent tax bill – of the local subsidiary.

As international attention has turned to the problem of tax base erosion, the OECD and the United Nations have developed rules and international agreements to prevent transfer mispricing. But how are these rules implemented in mineral-producing African countries?

To answer this question, we studied how Ghana, Guinea, Sierra Leone, Tanzania and Zambia have approached the problem. They face some major challenges.

First, when legislators draft international rules into national laws, they sometimes do not provide detailed specifications. This leads to uneven application and conflicts with taxpayers.

In Zambia, one mining company has exploited the lack of specification on the valuation of copper and cobalt exports sold to related parties to reduce its tax payments by as much as USD 74m.

Second, finance ministries and mining sector regulators often fail to coordinate. Different teams within these institutions and even within the tax administration would do well to share information and coordinate audits. This would help to build a comprehensive picture of transfer mispricing risks created by the mining industry.

In addition, there are capacity gaps that governments need to close. Even where resources are scarce, the case for investing in tax and transfer pricing experts who can capture tens of millions in fleeing tax revenue is undeniable.

Since its establishment in 2012, the international tax unit in Tanzania has generated approximately USD 110m in tax adjustments, with a budget of merely USD 130,000.

Another challenge is insufficient access to taxpayers information, originating both from taxpayers themselves and from authorities in foreign jurisdictions. Mineral rich developing countries face the additional challenge of assessing the quality and quantity of mineral exports.

Guinea and Sierra Leone, for instance, do not control the grade and humidity of the bauxite and iron ores shipped by mining companies to smelters in Europe, Russia, North America and China. This makes estimating value, and therefore taxes owed, difficult.

Amid these challenges, there are some promising developments.

In recent years, many civil society activists and engaged members of parliament have identified tax gaps as a major issue and lobbied for stronger rules. Such external oversight can help reinforce the political will to address transfer mispricing and reduce the influence of miners on governments.

International initiatives like the OECD’s work on base erosion and profit shifting are integrating developing country concerns with a landmark meeting seeking inputs from developing countries into international tax rules in Kyoto in late June.

Regional organizations such as the African Tax Administrations Forum provide both technical assistance to member countries and a platform to develop regional tools and approaches.

Some of these approaches are unorthodox, such as the move toward simplified tax rules that rely on publicly quoted mineral prices or set maximum deductibility ratios for a range of mining companies’ typical expenses.

However, creative solutions should be welcomed as mineral-rich African countries work to stop long standing practices that drain of public coffers and set back development.

Co-authored by Thomas Lassourd, senior economic analyst at the Natural Resource Governance Institute (NRGI).