The Future of Resource Taxation | Alexandra Readhead

In most cases, the ultimate owner of underground resources is the State. Governments grant companies the privilege to exploit these resources. And for that privilege, companies pay - in the form of taxes. It is not the only thing that countries get for their minerals, but taxes is very much at the centre of any benefit-sharing system. Is it time to reconsider the way in which we tax our resources?

In this episode, we speak with Alexandra Readhead from the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development and IISD about the future of resource taxation.

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Transcript

Åsa Borssén:
They say nothing is certain, except for death and taxes. Well, we can perhaps agree on death, but I wouldn’t be so sure about taxes. As the world changes, the way in which we approach taxation changes, too. And my guest today believes a re-think of the way that we tax natural resources is overdue. My name is Åsa Borssén, and this is Highgrade.

JINGLE

Åsa Borssén:
Welcome to The Natural Resources Podcast. In most cases, the ultimate owner of underground resources is the State. Governments grant companies the privilege to exploit these resources. And for that privilege, companies pay - in the form of taxes. It is not the only thing that countries get for their minerals, but taxes is very much at the centre of any benefit-sharing system. Is it time to reconsider the way in which we tax our resources? I'm speaking with Ali Readhead from the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development.

Ali, thank you for joining us.
 
Ali Readhead:
Thank you very much for having me.

Åsa Borssén:
Ali, you live and breathe tax policy, and every time we've discussed tax, your passion really shines through. But let's face it. For most people, tax is about the dullest thing in the world. I'd like to start by making a pitch in favour of taxation. Tell me, why should people care about tax?

Ali Readhead:
Thanks for the challenge!

Well, I think firstly because people pay them, or they will pay them if they're too young to pay them now. So that's a good reason to care. Secondly, because they rely on government to provide essential services such as health, education. These things all depend on tax revenues. And I think the third reason is that tax can help us create the society that we want. But right now, a lot of people are talking about wealth taxes, excess profit taxes. The idea being that if we tax the rich more, we can redistribute that wealth to poorer people by funding public services, for example, or taxing carbon to reduce pollution, to create a cleaner, greener world.

Åsa Borssén:
Speaking of paying taxes - take the Scandinavian countries, for example. People are happy to pay 60 percent tax because there is trust, there is this presumption that the payments that you make will benefit you. It's not quite the same when you know your payment is squandered. What is the role of trust in a tax system?

Ali Readhead:
Trust is critical to taxation. Citizens are right to be concerned about how their hard-earned dollars is spent.

So if there are insufficient nurses, doctors, teachers, they should ask their leaders where the tax revenues are going. If they see multinational companies not paying any tax at all, they should demand to know what government's doing to fix this. It's through paying tax that we can exert influence over government to be more accountable. We need to know where that money is going. But even more than that, we need to know that the tax being received by government is the right amount of tax. So one of the issues at the moment is that we have transparency over how much tax is paid. But citizens ask the question, is that the right amount of tax? And that's what we're trying to get to in our work at the IGF is to make sure that mining companies in particular are paying the right amount of tax.

Åsa Borssén:
And how do you know what the right amount is?

Ali Readhead:
Well, that's a difficult question. It goes back to what is the society that government is trying to create?  So what are their policy objectives? How to achieve those objectives? I think in the resource sector for mining, for oil and gas, it's particularly clear in that sector that, you know, these are publicly owned, finite, non-renewable resources. And I want to stress publicly owned citizens, own these resources under the ground and government represents them in that regard. And so I think in this sector in particular, the right amount of tax is really taxing as much as possible whilst, you know, ensuring that investors are able to recover their investment and then a return to capital. But beyond that, you know, the income should flow to the state.

Åsa Borssén:
So let's look specifically at how we're currently tax resources. What would you point to as some of the fundamental problems with the current resource taxation system?

Ali Readhead:
I think that what we see amongst the governments that we work with is that there is significant concern that governments are not collecting a reasonable amount of revenue from mining. There are many reasons for that. In some cases citizens perhaps have unrealistic expectations of what mining can deliver. We may also have difficulty understanding the nature of the industry. You know, mining is an industry with very long lead time. So it can be some time before a project is profitable and starts paying taxes. So, you know, those are all important factors. But setting that aside, I think there's concern that the tax system is not fit for purpose. And perhaps one of the reasons there is that we rely very heavily on profit-based taxes and profit-based taxes are harder to collect. So what I mean here is that, you know, the gross revenues that a company generates minus its costs, which gives profit, and then you tax that according to a certain rate, right? So if we rely on that, you can see immediately that there are challenges in terms of determining, one, what are those revenues and is that the right amount? And similarly, those costs, you know, are those accurate or are they inflated in order to reduce profits and to reduce taxes? So one of the challenges is that in relying very heavily on profit-based taxes, it can be difficult for governments to collect and also easy for companies to manipulate.

So I think that's a challenge. I think there are other issues in this sector in that there's a legacy of deals that have been done that perhaps provide overly generous fiscal incentives, which also defer government revenues…

Åsa Borssén:
So something like a tax holiday.

Ali Readhead:
Exactly. So I think our view is the tax holidays are not suitable for this industry. But that's precisely the kind of fiscal incentives that would mean that, you know, government revenues are reduced. And that's why we see concern amongst countries and citizens in particular that mining isn't pulling its weight.

Åsa Borssén:
And would you say that the main problem is in the actual legislation or the implementation of the legislation, if you see what I’m getting at?

Ali Readhead:
Absolutely, and that's very important to talk about the implementation issues, it’s very clear that in many cases, governments just don't have the human and financial resources that they need in order to implement more, perhaps more complex fiscal regimes. So I think the issue, you know, there are problems on both fronts. In some cases, you know, the fiscal regime hasn't been designed as well as it could, in other cases the issue is around implementation. There's a lack of resources on part of government and difficulty in administering these regimes. So that's where for us, we're very focused on this question of administration and implementation. That has to be at the centre of discussions around how to design fiscal regimes for the mining sector. Because if you can't implement it, if you can't collect the tax, then, you know, the law is not worth the paper it's written on.

Åsa Borssén:
Ali, you advise governments all over the world. Is there such a thing as a one size fits all tax regime?

Ali Readhead:
No, there is no one size fits all tax regime. Again, you know, it really depends on what it is the government's trying to achieve from this sector. But also what its capacity is. So, you know, the kind of tax system that Norway has, it's not necessarily going to be appropriate for Sierra Leone. So it's really important that the tax system takes into account both the specific objectives of the country, but also its capacity and what it's able to, the kind of fiscal regime that it's able to implement.

Åsa Borssén:
We hear a lot about the need for fiscal stability. But the world changes constantly and circumstances change. Why not think of a fiscal regime that adapts to these changing scenarios?

Ali Readhead:
Mining is a long-term business. 20, 30, 40 years in some cases. And whoever the investor is, whether they're private company or state-owned company, they need predictability. And there are a few reasons for that. The first is to promote bankability. So in order to provide certainty to lenders that the loans needed at the start of the project will be repaid. And then secondly, making sure that the investor can achieve an adequate rate of return for the risk taken. So it is important to have some predictability within terms of the fiscal regime. However, in many cases, that kind of predictability which, you know, takes off and takes the form of fiscal stabilization clauses. So where the government freezes the fiscal regime for a period. In many cases, those types of clauses have overreached. So they've locked in overly generous fiscal terms, often at a time when host countries were particularly weak, or they extend long after when the investment was repaid. So this has led to fiscal stabilization becoming a really contentious issue. Now, if you have a country that changes its fiscal regime regularly, that's going to create problems on all those fronts. How do we design a fiscal regime that accommodates these sorts of concerns from the outset? So, you know, a more flexible fiscal regime that adjusts to prices and profits. That would mean that perhaps, you know, governments would feel less compelled to change the fiscal regime. You know, when prices are high or when they fall. So it comes back to how do you design your fiscal regime.

Åsa Borssén:
And what are some of the mechanisms that can build in this flexibility in the tax system?

Ali Readhead:
A couple of examples - a sliding scale royalty - we think that this is a really good approach for countries. There are some risks as potentially, some risks associated with them know, just because mineral prices increase doesn't necessarily always mean that projects become more profitable because costs may also rise when prices rise. So, you know, as always, with fiscal regimes and tax policy, the devil's in the detail.

Other examples, of course, are taxes on rent. So resource rent taxes, which aim to increase government's share when the investor has achieved its rate of return, you know, the surplus profit. Once that rate of return has been achieved, then government will take a larger share of that profit. So that's also a progressive approach that should offer some stability. I think the challenge with that kind of mechanism is that you're looking at...this is a long time down the road, you know, for a mining project is 10, 20 years long. It may be some time before the company achieves its rate of return. So whilst something like a tax on rent offers some potential in terms of progressivity, it will also defer government revenues for some time.

Åsa Borssén:
Let's move on and look at this from a company perspective. At the end of the day, mining companies are as good as the quality of their resources and they would do anything to secure a world class mineral deposit. With that in mind, does tax policy really influence investment decisions by companies?

Ali Readhead:
I think as you said in your question to me, you know, the most important consideration for a mining company is the quality of the resource, which is location specific as well. So you can't just pick up a mine and move it to another country that has a more favourable tax regime. So what that means is that ultimately the most important thing is the quality of the resource. Other factors, such as access to the resource so, you know, is the resource kind of 500 kilometres from the nearest port. And it's going to require rail infrastructure and so forth. What about the governance environment? So the rule of law, access to justice, these sorts of questions are all going to be very important considerations for investors.

Of course, tax is not insignificant either, but it is a secondary concern relative to these other considerations, in particular the quality of the resource and questions around access. And, of course, you know, the price outlook and those sorts of things. So, you know, tax, is a less significant factor relative to other sectors, for example, manufacturing, where it's relatively easy to pick up your factory and move it to a country that offers you a better tax rate. You know, you can't move the resource- it’s fixed. So what that means is, is the taxes is important, but it's less critical. So that's where things like tax incentives and so forth are less relevant to this sector.

Åsa Borssén:
So going back to where we started – to trust. How important is trust for a company when making an investment decision?

Ali Readhead:
Very important. Again, this is a long-term relationship. As I said, you know, 10, 20, 40 years. So it's a long-term relationship. And I think companies and governments recognize that for the most part. And so it is important to build that relationship and to be able to trust one another. And what that means is, as we said earlier, you know, not trying to avoid changing the rules of the game partway through. But also on the part of the company or the investor, making sure that they fulfil their obligations, both in terms of taxes, but obviously social and environmental, and that they are acting in good faith so that they're not going off and engaging in kind of aggressive tax planning and so forth. So it's very important that both parties are able to trust one another. And that is challenging because mining is a dynamic sector as well.
 
You know, it's not easy to maintain as a good relationship throughout. But I think that's certainly where we need to head. And our ambition, particularly with the work on looking at the future of resource taxation, is how do we overcome the breakdown in trust that we see in the mining sector? How do we build a fiscal regime and more broadly, an investment environment that promotes trust and that enables us to get beyond kind of some of the challenges that we face at the moment to be able to develop these resources for the benefit of citizens, and investors of course.

Åsa Borssén:
And let's then look at the future and it is a future that is already upon us in part is already upon us because the industry is changing fast. We have the fourth industrial revolution, automation, digitization. How will all these changes impact resource taxation, do you think?

Ali Readhead:
The industry is changing quickly. The mine of the future is likely to mean less jobs for citizens and in particular, lower skilled jobs, which are really critical for many developing countries. Of course, less jobs mean less payroll taxes, which currently make up a large amount of companies’ tax contribution with less jobs the deal between investors and governments reduces to infrastructure and government revenues. So I think we anticipate seeing more pressure on governments to collect more tax from mining projects going forward to make up for the loss of jobs in particular. So I think that presents challenges for the sector, both for governments and investors. But it's something that we need to address head on to make sure that mining does contribute to the economies of resource rich countries. So taking away jobs or less jobs, make sure that the mining sector is able to contribute in other ways, and in particular that it contributes its full share to government expenditures in the form of taxes.

The other issue that we see is with automation and digitization is how does that change the mining value chain? So what are the drivers of value in the industry? Is it the intellectual property that resides offshore and so not in the country that's home to the resource, the intellectual property that is involved in automating the mine? You know, the driverless trains, the driverless trucks and so forth? How does the value change and where does the value get attributed along that value chain? And in so far as it is outside of the host country, that creates additional challenges as well, not just in ensuring that the host country benefits from the exploitation of their publicly owned resource, but it also creates potential implementation challenges from a tax point of view. Because if the mine is paying large royalties for the use of intellectual property, for example, that sits in, let's say, Luxembourg, a low tax country, that becomes a very easy way to strip profit out of the mine and transfer it offshore where the parent is registered or where the patent is located. So there are new challenges on the horizon I think in terms of the pressure on governments to increase revenue collection from the sector to make up for some of those shortfalls in other respects. But also, in terms of implementation, it gets more complicated now, tax administration in the mining sector. These complexities are present in other sectors. We look at Starbucks or Amazon, you know, these are the challenges the tax administrations face if the Starbucks brand is located in Luxembourg and so forth. But we haven't really had to deal with this so much in the mining sector. And that's changing. So it creates some new challenges for governments for sure.

Åsa Borssén:
Your organization, the IGF, is launching a new project called The Future of Resource Taxation. Are you going to find solutions to all these challenges in that project?
 
Ali Readhead:
Absolutely. Our goal here is to open up dialogue, to create a space for governments, for host countries, for investors, for citizens to come together and try and find a better way. And we really want to ask these questions of, you know, is the mining fiscal regime that we have currently, is it fit for purpose? Can it be improved? And are there alternatives? Are there other options out there that would better achieve government's policy objectives and create a more stable and trusting investment environment?

So I think that's the kind of conversation that we are trying to start. You know, it's not a one size fits all kind of thing. We’re not gonna come out with a blueprint on what the taxes should look like. But our goal is to facilitate that conversation, to work out what are the principles that are important in terms of designing the mining fiscal regime? What are the options? What are governments themselves doing to innovate, to try and overcome some of the challenges that we see? And this is really central for us as an intergovernmental agency that we really want to foreground the experience of our members in trying to find alternative pathways.

Åsa Borssén:
You're going to crowdsource ideas, which I think is very much a future way of working. Tell me how this will work.

Ali Readhead:
Yes, this program of work is a collaboration with the African Tax Administration Forum and the Inter-American Center of Tax Administrations in Latin America. And so through our partnership with ATF and CIAT and the IGF membership, we will be inviting governments to share their big ideas. So what are they doing from a policy, but also an administrative point of view to try and improve revenue collection in the mining sector? So we will be surveying governments, inviting them to come forward with their ideas. But not just governments. We want to go beyond that as well. Contributions from academia, from NGOs, from civil society, contributions from industry. We think it's important to make sure that all the options are on the table. So we invite people to get in touch. If they've got a great idea that they want to test out or they've seen something in practice that they think is worth exploring in more detail than where we're really excited to hear from them.

Åsa Borssén:
Then let's move on to my final question. We cannot ignore what is happening around us in terms of the pandemic and COVID-19. How do you see that will affect the extractives industry long term?

Ali Readhead:
Yeah, well, first and foremost, COVID is obviously an enormous public health crisis of a kind that we've never seen. And that is the most central issue that we need to address. And in that regard, you know, we're really concerned about the health of mine workers and the mining communities and working closely with member governments and industry to make sure that people can continue to work safely and so forth.

In addition to that, the economic impact is enormous as well. So I think we see this project as being very important in order to look at how resource rich developing countries in particular can begin to rebuild their public finances after COVID, so the need for public finances is greater than ever before, which is hard to even wrap your head around given the challenges that developing countries already faced in terms of generating tax revenue, paying for vital services. I mean, it was already enormous.

You know, the gap that they need to fill in order to achieve the sustainable development goals, for example. And now that gap is is significantly wider. Economies are totally decimated. And mining hasn't been uniformly affected in this regard. So, you know, in some cases, companies are in distress and projects are entering force majeure, suspending operations. But in other cases, companies are doing okay. Gold companies that have benefited from people investing in gold as a kind of safe haven. In those cases, companies could be required or invited to prepay taxes and royalties to help with cash flows during this time or at a minimum, relinquish any damaging tax incentives that might have been in their contracts.

In addition, COVID is speeding up certain trends that we were already is seeing. So automation, which we've talked about. Mining companies are moving quickly to try and reduce the number of workers present to kind of deal with the public health elements. So it's speeding up automation.

I think we're seeing significant pressure on the oil industry, which, you know, that's not new, but it's been exacerbated as a result of COVID. So that's putting pressure on revenues for resource rich countries as well. But it's also opening up new opportunities. So we knew that certain minerals were going to play an important role in terms of renewable energy.

I think it will also shake up the sector. So we will see more mergers and acquisitions. Who will the mining owners be in, six months, twelve months, two years’ time? So all of this creates opportunities for reform. Countries are keen to strengthen their fiscal regimes to explore alternatives, potentially increase their participation in certain projects.

These are all issues that we will take forward into our work on the future of resource taxation. They frame the kind of discussion that we intend to have, and we think this discussion is especially timely now as a result of all of these changes that we see and that there are there are significant opportunities.

Åsa Borssén:
That is the perfect way to end this conversation. Ali, thank you so much for joining us.

Ali Readhead:
Thank you very much for having me.

Åsa Borssén:
And thank you for joining us today. I hope you enjoyed this launch into the future of resource taxation. This podcast was done with support from the German Federal Ministry for Economic Cooperation and Development through BGR and the Inter-American Development Bank. Make sure to subscribe to our channel on whichever podcast platform you are using. We will be back very soon. Until then, so long!