Like other sectors of the economy, there are base erosion and profit shifting risks in the mining sector. Based on the ongoing work on BEPS, the IGF (Intergovernmental Forum on Mining) and OECD has released guidance for source countries on transfer pricing in the mining sector. The transfer pricing and tax avoidance issues identified in the sector are:
1. Excessive Interest Deductions
Companies may use related-party debt to shift profit offshore via excessive interest payments to related entities. “Debt shifting” is not unique to mining, but it is particularly significant for mining projects that require high levels of capital investment not directly obtainable from third parties, making substantial related-party borrowing a frequent practice.
2. Abusive Transfer Pricing
Transfer pricing occurs when one company sells a good or service to another related company. Because these transactions are internal, they are not subject to market pricing and can be used by multinationals to shift profits to low-tax jurisdictions. Related-party transactions in mining can be broadly grouped into two categories: (1) the sale of minerals and/or mineral rights to related parties; and (2) the purchase or acquisition of various goods, services and assets from related parties. Developing countries require sector-specific expertise to detect and mitigate transfer mispricing in the mining sector.
3. Undervaluation of Mineral Exports
Profit shifting via the pricing of mineral products sold to related parties is a major concern for many mineral exporting countries. For developing countries, these risks are elevated where government agencies lack the mineral-testing facilities required to verify the grade and quality of mineral exports, as well as detailed sector-specific knowledge of the mining transformation process and mineral product pricing.
4. Harmfull Tax Incentives
Mining and exploration tax incentives are common in developing countries. While tax incentives could encourage expansion of the sector, they may also lead to excess transfers of the gains from countries. It is unrealistic to expect that developing countries will forego incentives entirely due to the pressures of attracting investment. However, it is important that countries understand when tax incentives may be appropriate, how companies are likely to respond to incentives, and the distinction between tax incentives that permanently reduce taxes and from provisions affecting timing impacts.
5. Tax Stabilisation Clauses
Fiscal stabilization clauses are problematic from a tax perspective because they can freeze the fiscal terms in the contract such that changes in tax law may not be applicable to existing mines, foregoing significant government revenue.
6. International Tax Treaties
Developing countries consistently raise concerns about tax treaty abuse. Countries with abundant mineral resources need particular assistance
in this area, considering how treaty provisions might have a significant impact on taxes imposed on the mining sector.
7. Offshore Indirect Transfers of Mining Assets
Transfers of ownership of company assets (or the companies themselves) can generate significant income, which many countries seek to tax as capital gains. Transactions may be structured to fall outside the mining country’s tax base by selling shares in an offshore company holding the asset, without notifying tax authorities in the country where the asset/company is located.
8. Metals Streaming
Metals streaming involves mining companies selling a certain percentage of their production at a fixed cost to a financier in return for funds for partial or complete mine development and construction. Since the amount of financing provided is linked to the discounted mineral price, companies have strong incentives to agree to lower fixed prices to increase the up-front finance available. Streaming reduces the tax base of resource-producing countries, where royalties and income tax use sales revenue as part of calculations. There is virtually no guidance on these arrangements in the mining tax literature.
9. Abusive Hedging Arrangements
Hedging is a legitimate business practice in many commodity markets. It consists of locking in a future-selling price in order for both parties to the transaction to plan their commercial operations with predictability. A problem arises when companies engage in abusive hedging with related parties. They use hedging contracts to set an artificially low sale price for production and therefore record systematic hedging losses, reducing their taxable income.
10. Inadequate Ring-Fencing
It is possible that mining companies will have multiple activities within a country, creating opportunities to use losses incurred in one project (e.g., during exploration for a new mine), to offset profits earned in another project, thereby delaying payment of corporate income tax. Ring-fencing is one way of limiting income consolidation for tax purposes; however, getting the design right is critical to securing tax revenues while attracting further investment.
The following reports adresses some of these issues:
- Limiting the impact of Excessive Interest Deductions on Mining Revenue
- Tax incentives in Mining: Minimising risk to Revenue
- Comparables Data for Transfer Pricing Analyses – Prices of Minerals Sold in an Intermediate Form
- Toolkit for Transfer Pricing Risk Assessment in the African Mining Industry
Transfer Pricing Cases in Mining and Commodity