Taxing Oil, Gas and Minerals Across Borders Poses Challenges for Developing Nations

By Philip Daniel, Michael Keen, Artur Swistak, and Victor Thuronyi

Versions in Français (French), Português (Portuguese), and Español (Spanish)

Seventy percent of the world’s poorest people live in countries rich in oil, natural gas or minerals, making effective taxation of these extractive industries critical to alleviating poverty and achieving sustained growth. But national borders make that task much harder, opening possibilities for tax avoidance by multinationals and raising tough jurisdictional issues when resource deposits cross frontiers.

Familiar problems, but much larger

The countries with the most resources are commonly not those that most use them. So it’s no surprise that some of the world’s first multinationals were extractive companies, such as Standard Oil or Royal Dutch Shell, or that multinationals account for the vast bulk of government revenue from the sector (except where state companies predominate). All the techniques of tax avoidance associated with multinational activities—the subject of the G20-OECD project on Base Erosion and Profit Shifting (BEPS)—arise in the extractive industries. But while the problems there are similar to those found in other sectors, they are often on a larger scale—and with some distinctive twists.


Take, for instance, problems in applying the “arm’s length principle” to the “transfer” prices that multinationals use to allocate taxable profit across the countries where they operate. Under the arm’s length principle, transfer prices should be the same as those that would have been set by unrelated parties.

You might think that figuring out such prices would be easier in the extractive industries than in many others. Sometimes, as with oil, active commodity markets do indeed provide good starting points for transfer pricing. And hard-to-price intangibles (patents, branding, and so on) generally play a smaller role than they do in, say, the pharmaceutical industry.

But significant problems do arise in the extractive industries. For some resources (such as bromine, a mineral used in dyes and flame retardants, and its compounds) there are no regularly reported market prices. And the high tax rates applied in the sector can provide especially strong incentives to manipulate transfer prices; so too can the need to arrive at valuations not only for taxes on profits, but also for the royalties (charges on the value of production) commonplace in the extractive industries.

These and other technical challenges are addressed in a new book, International Taxation and the Extractive Industries, which draws on the advice that the IMF provides to its member countries. One issue that the book explores gives a flavor of the challenges that, while not unique to the extractive industries, loom especially large there. This is the very nerdy topic of “indirect transfers of interest,” meaning the use of a chain of companies to realize capital gains in a country where they will be lightly taxed, rather than where the asset that generates the gain is located. The sums involved can be huge: in Mauritania, for example, a potential gain of $4 billion on a gold transaction wasn’t taxed there.

Pipelines, railroads and borders

Geography presents some distinctive problems. Bringing resources to market can involve building infrastructure that spans national borders, such as a pipeline or railroad linking a mine to a port in a neighboring country. The book looks at the international law involved, and in particular at the difficulties of applying the arm’s length principle. As one chapter argues, the range of possible outcomes when trying to apply it is so large as to undermine the credibility of the principle itself.

Resource deposits that cross borders pose problems for coordination between countries—and a risk of conflict. The book looks at the various types of “unitization agreements” that can be reached when countries have agreed sea boundaries, and at experience with joint development zones when they do not.

The book addresses many other questions. To give just one example, how can the impact of international tax arrangements on incentives to invest in the extractive industries be assessed? We can’t claim that the book is a page-turner. But we do hope it will help those—whether in government, civil society, business or academia—who have to navigate these issues, which are as important as they are hard.


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