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Tax base erosion and profit shifting

Tax Treaties and the Mining Sector

August 7, 2018

Extractive industries often include a cross-border element, due to global business models and integrated value chains. These enterprises are undertaken by investors, licence holders, service providers, and suppliers who are often not resident in the “source country” (i.e., the country that is home to the mineral resource). In this context, a number of international tax issues arise, including in relation to bilateral tax treaties, sometimes referred to as double taxation agreements (or “tax treaties”).

Tax treaties clarify which contracting state can tax which income, and when a taxpayer can obtain a credit in one contracting state for tax paid in the other. In this way, tax treaties aim to eliminate the risk of double taxation i.e., the levying of tax by two or more jurisdictions on the same declared income, asset, or financial transaction. They also provide measures for administrative cooperation between governments, such as exchange of information.

However, tax treaties are not without risks for source countries. They may lose taxing rights in respect of extractive activities taking place within their jurisdiction, and thus forgo vital tax revenue. For example, a treaty may reduce the rate of tax on interest expenses.  In a large project such as the Oyu Tolgoi copper mine in Mongolia, the implications of a reduced treaty tax rate on interest can be very significant. It is estimated that Mongolia would receive USD 1 billion less over the life of this mine (undiscounted) on the basis that a 10 per cent treaty rate applies rather than the 20 per cent rate in the domestic law, according to Open Oil’s financial model. With such important revenues at stake, it is vital that the ramifications of tax treaty provisions are well understood by all parties as both treaties and projects are negotiated.

In the light of the specific tax treaty issues arising in the extractive industries, IGF and the International Senior Lawyers Project (ISLP) convened a meeting on June 25 in Paris entitled “Tax Treaties and the Mining Sector: Identifying issues and coordinating responses.”  The aim of the meeting was to begin to answer the following questions:

  1. What specific issues and challenges do tax treaties raise in the context of the mining sector?
  2. How do recent international and regional initiatives address treaty issues relevant to the mining sector?
  3. How can we best respond to the treaty issues, challenges and initiatives we have identified as priorities in the mining sector context?

The results of the exchange can be found in the meeting notes here. They will inform new work by IGF, OECD and ISLP on how developing countries with a mining industry need to consider the design and use of tax treaties to balance investment promotion and tax base protection. This is part of a broader program of work by the IGF and OECD to design sector-specific solutions to some of the most pressing base erosion challenges facing developing countries. ISLP will also publish a series of short primers on the basics of tax treaties. These are intended to help a variety of stakeholders better understand what tax treaties are all about.

For more information please contact James Reynolds and Alexandra Readhead.