Environmental Taxes in Africa

By Elvis Oyare

While taxation has traditionally been regarded as a revenue-generating scheme in which a person contributes to the running of the state in exchange for the maintenance of order in the society as well as the provision of several services, increasingly, taxation has become an instrument which the state wields in the performance of its regulatory function over various industries within its borders. Through the imposition of ‘specialized taxes,’ states are able to perform the dual role of restricting or mitigating the performance of certain activities as well as being a creative way to perform their traditional aim of raising essential fiscal revenue. Several of these specialized taxes exist, however, of relevance to our present discussion is such type of tax referred to as Environmental taxes.
Pursuant to the OECD, Environmental taxes are those taxes whose tax base is a physical unit (or a proxy of it) that has been proven to have specific detrimental impacts on the environment.1 These types of taxes are diverse and include amongst others energy taxes, carbon taxes, fossil fuel taxes, pollution taxes, transport taxes, and resource taxes.2
Carbon taxes are a form of excise tax on the producers of raw fossil fuels, based on the relative carbon content of those fuels. These taxes discourage the use of fossil fuels that are carbon-intensive by making them more expensive. Energy taxes are taxes on energy products which include consumption of electricity, consumption of fuel, and emission of greenhouse gases. They are levied on the energy-producing source/ the installation plant. Fossil fuel taxes are downstream taxes applied to fossil products, such as diesel, gasoline, and vehicular natural gas, that are used for road transport. Transport taxes on the other hand are traditionally qualified as a tax that is related to the ownership and use of motor vehicles. Pollution tax is calculated based on the emission of different gases (i.e. NOx, SOx, CO2 ) or ozone-depleting substances and harm caused to water resources or land using different materials (chemicals, pesticides) or anything that dissolves in nature or reacts to it. A resource tax refers to a tax levied on the extraction of a natural resource.
Following an increase in emissions and environmental pollution as a result of certain industrial activities, a number of African countries have begun introducing environmental taxes to curb these activities into their fiscal regime. These countries, although the list is not exhaustive, include South Africa; Kenya; Ghana; Egypt amongst others.3
According to ATAF, based on a survey of 37 ATO countries, revenues from environmental taxes average 0.13% of gross domestic product. Whilst these are the lowest contributor to GDP, there is scope for these taxes to increase the tax take.
As the rest of the continent endeavors to catch up on the imposition of environmental taxes, their policymakers must conduct empirical studies in order to avoid any unintended environmental or fiscal consequences where they adopt a one-size-fits-all approach and just apply taxes seen to be applied in other countries. There are optimal alternatives and it is essential that tax administrations are cognizant of the taxation principles of neutrality; efficiency; certainty and simplicity; effectiveness as well as fairness when intending to introduce such taxes.4

REFERENCES
1. ‘What Are Environmental Taxes? | Japan Center for a Sustainable Environment and Society (JACSES)’ http://jacses.org/en/paco/envtax.htm accessed 6 February 2022

2. Ibid

3. Kombat AM and Wätzold F, ‘The Emergence of Environmental Taxes in Ghana—A Public Choice Analysis’ (2019) 29 Environmental Policy and Governance 46 https://onlinelibrary.wiley.com/doi/abs/10.1002/eet.1829 accessed 6 February 2022

4. OECD, ‘Fundamental Principles of Taxation’ accessed 6 February 2022

Fiscal Regimes Used in the Extractive Industry: A Developing Country Perspective

By Mary Ongore

Introduction

The discovery of natural resources in a country can have a significant impact on the revenues of a jurisdiction. These benefits can however only be realized where there is strong governance. The careful design of the fiscal regime is also imperative. This blog will review the types of fiscal regimes available, as well as the considerations developing countries, should make in designing them.

Types of regimes

The main fiscal regimes used to tax the extractive industry are contractual regimes or concessional regimes (also known as tax/royalty regimes).

Concessional regimes

Under concessional regimes, the natural resources belong to the investors who in exchange pay royalties on the volumes extracted. In addition, they will also pay some form of profit-based tax. The royalties will usually be based on the volume of products extracted products while the profit-based tax will usually be in the form of company income taxes, excess profits (or variable income) taxes, and resource rent taxes.

In the early years of extraction, revenues from profit-based taxes will generally be lower as cost recovery applies. Royalties on the other hand are calculated on the gross volume or value of production with no deduction permitted for costs and are payable once production commences. As a result, royalties are generally easier to predict and administer and ensure a steady income stream as they do not depend on the price of the product or revenues earned. The royalties are therefore favorable where governments want to raise revenue early in the project life. However, as they are not profit-based, they may deter exploration where margins are slim and where projects are only significantly profitable on a pre-tax basis. The profit-based taxes are however not progressive unless the tax rate scales are used. In addition, they are difficult to administer.

Bonuses are also commonly used under this regime and represent upfront payments made without full knowledge of the extent of production values. Although tax/royalty regimes are common in mining industries they are also used in the oil and gas industry.

Contractual regimes

Contractual regimes on the other hand can either be production sharing contracts or risk service contracts. These regimes are both are used in the oil and gas industry but are less common in the mining industry.

Under production sharing contracts, the revenues from extraction are shared between the host country and the international oil companies who work as a contractor. There may also be a royalty on gross production. A percentage of the remaining production known as cost oil is allocated to the investor to cover its cost of production. There are limits on the recoverable cost oil in a given year and costs exceeding the cost oil allocation for a particular year are generally carried forward. After the deduction of royalty amounts and cost oil, the remaining amount known as profit oil is further allocated based on pre-agreed formulas and percentages. This profit oil is also subject to regular profit-based taxes with deductions applying based on the tax law. The cost oil ceiling allows the government to recover early benefits.

On the other hand, under risk service contracts the government owns the oil and gas and the government pays a fee to the investor for exploration and production services. International Oil Company works as a service provider in different stages of the project. The fee paid to the investor may also be subject to profit-based taxes.

There can also be additional taxes in form of bonus payments, whether signature bonus or production bonus. Most tax regimes allow for bonuses to be tax-deductible since they are a cost of doing business; the larger the tax relief for the bonuses offered in the contract, the greater the magnitude of the upfront bonus is likely to be. However, they are typically not allowable for cost recovery under PSC, which ensures that the state receives more profit oil.

Other taxes

Other taxes on the extractive industry include VAT on domestic consumption which is often refundable on the export of the products. Sales or dispositions of assets are also taxable under ordinary income tax or in the form of capital gains tax. Taxes are also levied upon profit distribution whether done through the use of dividends, interest, royalties, and service fees to subcontractors.

General considerations

Whilst there are differences between the two regimes, it should be noted that there is room for case-by-case negotiation under both. Tax and royalty schemes originated in the mid-1800s and generally prevailed historically. To date, they continue to dominate in OECD countries. In developing countries, however, contractual regimes which emerged in the 1950s are more common based on the desire to retain sovereign rights over a country’s resources. While it was generally argued that concessional regimes place oil companies in a much stronger position and allow them to exploit governments of oil-producing countries, it has been shown that such exploitation was not because of the fiscal regime, rather it was a combination of different political, economic, social and legal conditions, which have changed dramatically since then. In the early days, host governments often lacked expertise in the conclusion of concessional contracts, often giving sweeping powers and rights to extractive industry companies through one-sided agreements. Benefits to host governments were limited to royalties based on the volume of production at a flat rate rather than a percentage of the value of the oil produced. However, post the second world war, a new generation of concession agreements was developed which granted the host government more rights.

Although contractual regimes are preferred by developing countries, it has been shown that it is possible to design concessional regimes in a way that results in similar economic outcomes as contractual regimes.

General considerations

In the design of a fiscal regime, countries should generally adopt a regime that best suits them. Whilst it is advisable to learn lessons from other countries, as there is no one-size-fits-all regime, countries should take the following considerations into account when designing their regime.

The fiscal regime adopted should result in a maximum return for the government while ensuring optimum economic efficiency. This can be done through the use of competitive tax rates and good use of deductions in the tax regime. Governments may, however, also design a fiscal regime that results in a lower effective tax rate because they would like to attract investment and compensate for high costs, high geological risk, and political risk. Where there is high volumetric potential a higher tax rate can be adopted.

Price volatility should also be considered particularly in the oil industry. Governments tend to favor high tax rates during an upswing in prices with conversant reduced tax rates during a downswing. It should however be noted that changing the fiscal regime is often a slow process. As a result, fiscal regimes should be flexible and responsive to these changes.

As it pertains to the control of the natural resources, although the government control is higher in contractual regimes, it has been shown that government control can be retained in concessional regimes through the legal and regulatory framework. Under concessional regimes, governments can still exploit the competitive instinct of international oil companies and build successful oil and gas regimes in a short time and benefit from the deployment of resources to the oil and gas industry. From an economic perspective, the government’s tax rate can ensure that there is commensurate compensation irrespective of the ownership of the underlying ownership.

Another consideration to be made in the design of the fiscal policy is stability. Investors prefer regimes that remain stable throughout the life cycle of exploration. Regimes that constantly change deter investment. Generally, a certain level of instability is acceptable where it is compensated for via a low tax-take. In addition, stability ensures that revenues are predictable for the host government.

Finally, the chosen fiscal regime should result in administrative efficiency. Tax administrators should be well appraised on how the regime works in order to prevent exploitation from the extractive industry operators.

Conclusion

As there is no fixed regime design that benefits developing countries, due care should be taken in the design of the regime in order to ensure that it is best suited to the individual circumstances of each country. The central fiscal issue is ensuring a ‘reasonable’ government share in the rents often arising from the extractive industry.

Although contractual regimes are perceived to be tougher and therefore the optimal regime for developing countries, concessionary regimes can also be designed to be similarly tough. Governments should ensure that they focus not just on the tax rate but also the way fiscal reliefs are granted. What is of utmost importance is the way the tax base is defined. Poorly designed fiscal regimes, however, can seriously undermine revenue potential. An optimal regime will consider the fluctuations in revenues during the cycle of exploration and ensure that their regimes can adapt to them. There are also various ways of ensuring fiscal flexibility through the linking of the tax/royalty/production share to proxies for profitability and it is encouraged to take these into account in developing the fiscal regime.

The evaluation criteria during the design of regimes can include an analysis on whether the regime is progressive, encourages efficient development, results in dependable revenues, and results in a favorable sharing of risk between investors and governments.

The IMF has developed a Fiscal Analysis of Resource Industries (FARI) tool which can be used to model cash flows for petroleum and mining projects. This is a useful tool that has successfully been used in many jurisdictions and assists with the optimal design of the fiscal regime.

The Mozambique Hidden Loans Case: Securing Fiscal Legitimacy in developing countries

By Mary Ongore

In 2016, it was revealed that three semi-public entities had illegally taken on debts of over USD 2 billion that were backed by government guarantees. The borrowing companies were Mozambique Asset Management (MAM) (USD 535 million), ProIndicus (USD 622 million), and Empresa Moçambicana de Atum (Ematum) (USD 850 million) which had all been incorporated between 2012 and 2014. All three entities were linked to Mozambique’s state security and intelligence services (SISE) and shared a common CEO, a director of the SISE.

The loans were purported to have been taken in order to establish tuna fishing and maritime security businesses and the lenders were Credit Suisse, VTB Bank, and the European bond market. The basis for such loans was the need for Mozambique to secure assets of oil and gas firms operating in Mozambique waters. The repayment of the debt was meant to be from revenues raised from annual fees oil and gas firms transiting the Mozambique channel would pay for security services. Additionally, revenues from tuna fishing would also assist in the repayment of the loan. No such payments had however been received and the main oil and gas firms in Mozambique had signed no contracts with the semi-public entities. Although future revenues from oil and gas extraction did not act as collateral for the loans, the lenders generally believed that these future revenues would increase the likelihood that these loans would be paid. It is largely believed that these funds were pocketed by politicians and politically exposed persons.

These loans, however, violated paragraph 2 of Article 179 of Mozambique’s Constitution in that they had not been submitted to the National assembly for assessment, approval, and monitoring. They also breached the domestic annual budget appropriation bill which put a top limit on government borrowing.

In 2015, Mozambique approached the IMF for the emergency balance of payments assistance. Following the first disbursement of the IMF loan, during debt restructuring, in 2016 the IMF discovered the loans and suspended general budget support. This move was followed by the World Bank which suspended aid disbursements. G14 donors also suspended general budget support while the US placed its annual aid allocation under review. The country is now deemed to be in public debt distress.

These loans illustrate how illicit financial flows not only flow from developing countries but also allow these flows to return to developing countries. These debts met the description of odious debts as they were illegally gained without the consent of the public and failed to provide any tangible benefit. In 2020, the Mozambique constitutional court ruled that the loans were illegal and unconstitutional and as a result, the government was not obliged to pay them back.

This case illustrates the role constitutional and legal safeguards can be used to protect developing countries from taking on excessive levels of debt. This is mainly achieved by ensuring fiscal legitimacy in debt taking by requiring accountability and transparency in borrowing. It also shows the importance of having widely available published information on debt taken on by both the state as well as its publicly owned entities. The Mozambique ruling also shows that there should be better governance of financial institutions in developed countries to ensure that they do not issue odious debt without following proper procedures and conducting due diligence. Although illicit financial flows move from developing to developed countries, this case shows that developed countries also have a role to play in governing lending institutions in their jurisdictions in order to combat Illicit Financial Flows. The key to tackling this problem is the issue of access to information both by developing and developed countries. Fiscal legitimacy can, therefore, only be attained where citizens of developing countries have access to information. Without cooperation from developed countries, it would be difficult to govern borrowing in developing countries which would allow for corruption and revenue loss that will further plunge developing countries into poverty.