Global Tax Reforms Proceeding with Major Mining Implications
On January 14 and 15, 2021, the Organisation for Economic Co-operation and Development (OECD) will hold a public consultation on the latest Pillar One and Pillar Two Blueprints to address the tax challenges arising from a digitalized economy. The primary objective of the OECD’s “digital tax project” is to ensure that digitalized companies carrying out business in places where they do not have a physical presence pay tax in these jurisdictions. However, the proposals are, in fact, much broader, with potential implications for mining. Resource-rich countries need to pay close attention that the reforms do not undermine revenue collection from the mining sector.
In a previous commentary from March 2020, resource-rich countries were cautioned that mining was not exempt from the global digital tax reforms and that there was potentially a lot of revenue at stake should the reforms go ahead. Since then, the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) has further developed the proposals. Pillar One (228 pages) and Pillar Two (250 pages) were published in October 2020, along with an economic impact assessment of the proposals (284 pages). The OECD also collected and published comments from a range of stakeholders.
What do these recent developments mean for the taxation of the mining sector? This commentary considers the extent to which the latest blueprints address the concerns raised last year, as well as new issues that have emerged. It also signals important points of discussion for Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development (IGF) member countries ahead of a more detailed briefing in the coming months.
Overall, the reform remains on the same track. Despite serious criticisms saying the proposal is both too complex and insufficiently bold, the OECD Secretariat maintains the two-pillar approach. Pillar One creates a new taxing right for businesses selling goods and services digitally in countries where their users or consumers are physically located (“market countries”). Pillar Two addresses tax competition and profit shifting in all economic sectors through rules to ensure all global profits of multinational enterprises are taxed at least at a minimum effective tax rate. Thus, despite being labelled as digital tax reform, this initiative is, in fact, much broader and requires the attention of the mining sector.
Pillar One: The allocation of taxing rights to the market country
Amount A: Establishes a new taxing right in the market country
The primary issue for resource-rich countries with respect to Pillar One has been addressed. The latest blueprint clearly excludes the extractive industries—mining and petroleum—from the proposed new taxing right that would allocate a share of multinationals’ global profits to market countries (otherwise known as “Amount A”). This is entirely appropriate. Minerals are generic goods that are sold and priced on the basis of their inherent characteristics rather than on other factors such as marketing. The primary taxing right correctly resides with the resource-producing country, a position the OECD agrees with, which has led to the whole mining value chain being carved out of the reform. The one possible exception to this carve-out is gemstones, which may benefit from marketing.
Amount B: Allocates a fixed return to marketing activities in the market country
Amount B allocates a fixed return on sales to related entities that already have a physical, taxable presence in the market country and that carry out basic activities to market their goods and services in that jurisdiction. So far, there is no carve-out for mining. While there are advantages to formulaic approaches, a fixed return on sales is not appropriate for marketing services in the mining sector.
Marketing plays a limited role in the sale of mineral products and should not benefit from a fixed return on sales.
Marketing plays a limited role in the sale of mineral products. According to the International Council on Mining and Metals, “minerals and metals are physical assets with limited value generated from marketing intangibles.” Either extractives should be carved out of the fixed return on sales, or an industry-specific rule should be developed.
Ideally, an industry-specific rule would also include marketing hubs in low tax jurisdictions—a major source of profit shifting in the mining sector. The rule would allocate all profits from the sale of minerals to the resource-producing country, except to the extent that the marketing entity could prove that it contributed additional sales value above a nominal percentage of group revenues, in which case it would get a fixed return on operating costs. This combines the formulaic and simplification aspects of the proposed Amount B but with a focus on anti-abuse in mining specifically.
Amount C: Provides a process for resolving disputes arising from the fixed return (Amount B)
While this section has now been renamed “Tax Certainty,” it nevertheless continues to put much emphasis on mandatory binding dispute resolution. While mandatory binding arbitration is no longer the only option for dispute resolution—a dispute prevention process has been added—it now applies to “all disputes related to transfer pricing and permanent establishment adjustments,” not just disputes arising from the allocation of profits to the market country. This puts international tax disputes outside domestic law, significantly undermining national sovereignty.
Pillar Two, also known as Global Anti-Base Erosion (GloBE): A minimum effective tax rate
The lack of details around Pillar Two made it difficult to assess the proposal last year. The blueprint provides details on many issues that were previously identified, which will be analyzed closely in a forthcoming technical briefing. Below are the most important points.
Under GloBE, mineral-rich countries can hope that companies will have less incentive to keep using tax loopholes that depend on tax havens—but there are several elements of the proposal that could be problematic.
The objective of GloBE is now clear: to remove incentives for multinational companies to shift profits away from their countries of operation or residence to low-tax countries and investment centres. It therefore creates a minimum tax, which will be triggered whenever a multinational company pays less tax, as a proportion of its profits, in a single country and in a single year than the agreed minimum tax rate. The difference can then be collected by the tax authority of the country where the company is headquartered.
Under the current proposal, what mineral-rich countries can hope to achieve is that companies will have little incentive to keep using tax loopholes that depend on tax havens. This would be welcome, given the number of cases where mining companies shift profits to offshore marketing hubs or route their intercompany loans through empty shell companies in low-tax jurisdictions. But there are several elements of the proposal that could be problematic for developing countries:
- The threshold for companies to be included in Pillar Two is set at EUR 750 million of global consolidated annual gross revenue, which is likely to exclude many smaller companies operating in developing countries.
- The way that taxes and profits will be assessed to calculate an effective tax rate by country and by year will be different from local tax rules, which typically allow a faster depreciation of exploration and development expenses, which are significant in the mining sector. Most mining projects in cost-recovery periods therefore declare profits on their financial statements but no taxable profit, a situation that reverses over time. During this period, it may look as if the mine’s effective tax rate is under the minimum, which would require the mine to pay taxes to a foreign jurisdiction before the resource-owning country and increase its overall tax burden.
- Because of their design, GloBE rules would create more direct revenues for richer and larger countries, where mining companies are headquartered, than for developing countries.
Some criticize GloBE for not being ambitious enough. Designed differently, a minimum tax could end the “race to the bottom” by addressing tax competition not only from small states acting as tax havens but also between resource-rich countries. Such a shift would require coordination by the countries concerned and some important changes to the current proposal. For example, the minimum effective tax rate would need to be set at a higher rate. Illustrative examples in the blueprint and the economic impact assessment use rates ranging from 7.5% to 17.5%. These options would do little to prevent downward pressures on the statutory rates in the mining sector, typically 30%.
What can the governments of resource-rich countries do?
As the reform progresses on the international agenda, it is important that governments develop positions that defend their current and future right to tax their natural resources. Beyond the team of international tax negotiators participating in the IF (in most cases from the ministry of finance), other relevant departments in the tax administration or the ministry of mines should be consulted. The OECD Secretariat has shared a country-specific economic impact assessment of the reform blueprints with each country government. Governments should scrutinize these assessments internally and across agencies. Additionally, governments in countries with similar interests could then further strengthen their positions through regional platforms such as the African Tax Administration Forum or by adopting a joint position through platforms such as the IGF.
Inevitably, there will be mining sector-specific profit shifting risks that cannot be addressed by the international tax reform package. These risks, along with other revenue collection challenges, will be considered as part of the Future of Resource Taxation, a joint project with the IGF and African Tax Administration Forum to identify and popularize innovative tax and revenue-generating policies in the mining sector.
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