Domestic Resources Mobilisation (DRM) & State Legitimacy : Why Taxation Matters
Domestic resource mobilization (DRM) can be defined as the accumulation of savings from resources generated domestically and their investment in socially productive activities. In a broad sense, DRM entails the mobilization of both human and financial resources available within the country.
In poorer and developing countries, DMR is primarily meant to increase the fiscal capacity of the country and improve the social return of public investments, promoting economic growth, internal consumption, an efficient and appropriate provision of public good and services from the State. DMR, therefore, are pivotal to a sustainable development of a country and, being domestic, presents other advantages compared to Overseas Development Assistance (ODA) and Foreign Direct Investments (FDIs), such as not having conditions/ political o economic strings attached by donors, and being less volatile and more predictable than foreign investments which, instead, vary according to the interests and objectives of the investors.
Furthermore, DMR promotes domestic ownership and greater control over the resources available by the State, thus representing the most significant and sustainable, autonomous source of financing for development. DMR are divided into private (mostly households and corporate savings) and public savings which are generated through taxation.
Taxes are of different types ( direct such as income taxes, indirect such as VAT or value added tax, corporate taxes, royalties…) and serve multiple purposes for the well-functioning of a state: primarily they are used to redistribute wealth among citizens, ensuring the provisions of those public goods and services ( health, education, defence, infrastructure construction etc…) which should be enjoyed by everyone regardless of their economic possibilities. In short, tax is the first sources of government revenue to ensure an efficient socio-economic system available to all citizens. It also encourages a better governance, as public expenditures financed through collecting taxes allows citizens to control and monitor their government, rendering them accountable and responsive to the needs of their citizen. It is precisely for this reason that tax can and should be considered at the core of the social contract between citizens and the State, can increase the legitimacy of state institutions towards their constituency and, eventually, improve the overall functioning of democracy in developing countries.
Taxation in the Mining/ Natural Resource Sector
The mining industry is a complex economic sector, as resources are normally owned by the state but mostly extracted by private sector, their exploitation involves high risks as there is no guarantee of discovery or mine profitability and the development of a mining industry is capital intensive, with long lead times and massive impacts on the social and natural environments. Mineral prices are highly volatile and, therefore, companies normally require “stability clauses” to mitigate and minimise the risks associated with extractive activities. However, governments want to attract foreign investors and maximise the profitability of their minerals, hence States in resource rich countries often enter unfavourable deals with TNCs conceding them extremely favourable clauses and terms which prevent state authorities from getting sufficient revenues and allows companies to subtly dribble international human rights, social and environmental laws and standards, leaving inhabitants of mining communities far worse off.
Furthermore, whist several countries in Sub Saharan Africa are mineral dependent (meaning that a country’s mineral export accounts for >20% of total exports) the mining value addition ( the capacity to generate extra worth that comes from each stage of processing the minerals adding value to the ores themselves and/or to the domestic economy), still remains dramatically low across the region, and so is the contribution of the mining sector to the generation of fiscal revenues for the producing states.
At the first ATRN (African Tax Administration Forum) International tax workshop held at Victoria Falls in September 2013, participants agreed that governments’ shares of mining income should be between 40% to 60% in mining and between 65% to 85% in petroleum; all shares below this range should be cause for concern and regret. In 2013, however, Zimbabwe’ s mining sector only contributed 13% to the state coffers ( EY Zimbabwe 2015).
Main Sources of Government Revenues from Mining
Government should accrue revenues from its mineral resources primarily through the taxes that mining companies pay to the state, according to project-specific “mining agreements” which discipline the fiscal term of the contract between the stakeholders. Unfortunately, disclosing the revenue sharing agreement still remains a key challenge for many African countries; in Zimbabwe, like in many other regional neighbours, the government does not publish the mining contracts it signs, nor the payments received by mining companies, thus keeping precious and essential information concerning the extractive sector away from the media and the general public, despite minerals being a public asset whose exploitation should benefit the whole population. Furthermore, secrecy and lack of access to information increase the risk of corruption and leakages of revenues, whilst facilitating the diversion of companies profits towards low-tax jurisdictions. Therefore, it is of outmost importance to advocate for the government and the TNCs to abide by international standards disclosing mining agreements as recommended by initiatives such EITI or several international stock exchanges.
Overall, the main type of taxes through which the government should generate revenues from mining are:
- Royalties : A royalty can be defined as a payment to the owner of mineral rights to be entitled to extract the ore from the ground, on the basis of a mining agreement. The royalty payment is based on a portion of earnings from production and varies depending on the type of mineral and the market conditions. A royalty can be associated to the Intellectual Protection Property (IP) rights which safeguards artistic production. It contains an element of ownership, as the mining company pay for utilising a non renewable resource which belong to someone else. Since second world war, however, this kind of payment has been increasingly replaced by income-based taxes. According to ZIMRA website, the rates of royalties for minerals are the following (update to January 2012):
|Rates of royalties with effect from the 1st of January 2012|
|(b)||Other precious stones||10%|
|(c)||Gold||7% (5% as of 2014)|
|(e)||Other precious metals||4%|
|(h)||Coal bed methane||2%|
- Corporate Income Tax : Corporate Income Taxes (CIT) are payments assessed on the profits made by the business company once all the expenses and eligible costs have been deducted. Simply put, CIT are taxes paid on the income generated by the firm. The main problem with the growing recurrence to income-based taxes, is that, unlike royalties, the latter are paid as percentage of profits made by companies. Hence, whilst royalties allow governments to collect revenues from the earliest stage of extraction, before being able to obtain CIT, the government needs to wait for the activity becomes profitable. Therefore, in several occasions mitigations measures are taken to attract TNCs to operate in the country, such as conceding tax holidays (incentive schemes which envisage tax reduction or elimination to firms) until the activity has generated sufficient returns. For this reason, companies often wait several years before declaring profits and “buy time” declaring losses until when they have recovered the money used for investment and generate sufficient earnings. Most of the time, after this period, they simply leave and close down the company, to open somewhere else or under a new name.
- In Zimbabwe, according to Oxfam and the Publish What You Pay Coalition, there are 2 mechanisms which might be used by mining companies to reduce their taxes: first of all, mining companies are allowed to pay the whole amount in the year that costs were incurred, thus reducing the amount of payment to the state fiscus. Secondly, there is no limit that past losses can be carried to claimed against future profits declared. Overall, CIT are more volatile than royalties, as companies tends to recur, whenever possible, to mechanisms of tax avoidance (for instance through transfer pricing –> see section on Illicit Financial Flows and International Tax Governance) increasing declared losses and reducing income, or exploit other tax incentives in order to pay less.
- Withholding Taxes : Taxes paid at source on payments made by the mining companies to non-resident (foreign) companies for good and services they have provided to them. The rationale of this kind of tax is to allow the government to capture income from international financial transaction before the money leave the country. As ZIMRA website reports ” The legal requirement is that a 10 percent Withholding Tax is deductible from all amounts payable to all persons who enter into contracts, of an aggregate amount of USD$1,000.00 or more, with the State or a statutory body, a quasi-government institution and taxpayers who are registered with the Zimbabwe Revenue Authority (ZIMRA), unless the payee furnishes the paying officer with a tax clearance certificate “.
An optimal fiscal regime for the Extractive Sector…. and the challenges to achieve it!