10. Auditing costs: Potential for exaggerationVerifying that taxpayers do not exaggerate costs to reduce their taxable income is a core activity of the revenue authority, but it is more complex for EI projects due to the length and significant costs of exploration and development work where they incur heavy costs before earning profits. As discussed above, such costs lead to substantial losses carried forward which can reduce the taxable profits earned.
As a result, revenue authorities need to devote resources to audit the costs of EI projects in the years before profits occur and taxes are due. This is not easy for revenue authorities with resource constraints to do, especially given pressure to meet short-term revenue targets.
In the petroleum industry, joint ventures between states and investors are more common. This makes auditing much easier as the state is directly involved in production giving it much greater access to information on costs.
Transfer pricing to avoid paying taxes
Transfer pricing is a common tax avoidance scheme whereby a company pays excessive costs to a subsidiary or affiliate within its group of companies. This erodes the tax base by shifting profits to low tax destinations, often tax havens. These problems are not exclusive to extractives. To address this the OECD has developed a Base Erosion and Profit Shifting Action Plan (BEPS) to help ensure that the international tax system makes profits taxable where ‘economic activities take place and value is created’. This and similar initiatives indicate the international tax landscape is changing rapidly and it is worth maintaining attention on BEPS and similar initiatives.
Preventing “treaty shopping”
Double tax treaties, or DTTs can encourage investment and prevent ‘treaty shopping’ by ensuring that the management and staff of the parent company should be located in the resource/host state. This avoids the situation whereby a company not based in source nation seeks to benefit by setting up a ‘paper’ company abroad, a practice known as ‘treaty shopping’.
Special Cases: Artisanal and Small Scale Mining
Although the extractives sector is normally dominated by a few, very large taxpayers, for precious minerals in particular there are many smaller ‘producers’/taxpayers, collectively referred to as Artisanal and Small Scale mining sector (ASM). The ASM sector will rarely be a significant source of revenues, at least at a national level. However, establishing a simple fiscal regime for the sector combined with clear taxpayer guidance on how to comply can assist formalisation of activities. Many in this sector use traders and dealers to get their minerals to markets, meaning that the formalisation of such traders and dealers can help in ensuring proper record keeping and thus improve revenue collection.