knowledge and the instruments it offers. Even if a single fiscal instrument could be described as “simple,” the fact is that at the extraction phase, oil, gas, and mining tend to be subject to a variety of fiscal terms that can include royalties, corporate income tax, windfall or additional profits taxes, production sharing (although not in mining) when selected, bonuses, fees or other contributions, and indirect taxes. Having too many different tax instruments under a given tax regime gives a wrong signal to potential investors on the effective tax severity and prevents a clear understanding of the interaction between the various taxes. A basic fiscal design rule is to try to minimize the number of fiscal instruments and to focus on the most important ones in terms of revenue capability.
Rewards and risk sharing derived from a fair fiscal regime
Designing a tax on rents from the extractive sector requires appreciation of some basic facts of EI life. In the vast majority of cases, foreign investment will be required (see chapters 1 and 3). The drivers to attract such investment are well established. Governments provide mineral or petroleum rights to private sector companies, with the expectation that the state will subsequently benefit from tax payments if commercial mines or fields are exploited. By receiving tax revenue, the government converts a resource in the ground into both social and economic capital (Sunley, Baunsgaard, and Simard 2003, 153). Correspondingly, private companies invest in exploration and development projects when a fair fiscal regime applies, with the expectation of making a profit commensurate with the risks involved and their cost of capital. For both parties, there are potential rewards and risks, and the balancing of those will determine ultimately what EI sector development takes place and how beneficial it is to the government, the investor, and the local community (Stiglitz 2007; Date-Bah and Rahim 1987, 133n35). The fiscal regime is a key determinant of how EI sector income is shared between the investor and the government. There is no model that would immediately lead one to conclude what is a “fair” or “reasonable” share. However, there are recognized guidelines and best practices to be followed when a country designs a fiscal regime and selects its terms in hopes of establishing a regime considered fair by the parties. Even after initial agreement, there is no guarantee that this sharing of benefits will be sustainable over the long term, given the volatile and inherently uncertain investment life-cycle revenues.
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Credibility and predictability of a fiscal regime
A recurring theme in the literature on fiscal design concerns the credibility of a fiscal regime.1 A fiscal regime must be credible to attract investment, but it also must be credible to the citizens of the country applying it. If not, it is likely to be challenged over the medium to long term. Linked to this credibility theme are the pressures on governments to demonstrate returns on publicly owned resources: they can act as a powerful incentive to adopt fiscal instruments that deliver early revenues from resource development. Reducing the frequency of changes to extractive fiscal legislation and other mining and petroleum legislation will increase their credibility for investors, who value stability. The fiscal regimes will also be considered more predictable for effective decision making. Impact of different activities and contexts on fiscal regimes
Differences of approach and in fiscal regimes arise depending on whether the activity is oil, gas, or mining, even if they share similarities as “extractives.” Differences will also emerge according to the context in which a fiscal regime is designed (or updated). For some countries, the existence of active contracts inherited from the past will constrain the scope for change and force it to be incremental. (Examples can be found from mining in Guinea, Lao People’s Democratic Republic, Sierra Leone, and Tanzania.) These differences are highlighted in this chapter, along with the fiscal solutions to them. Some understanding of comparable country settings and their tax regimes is also required, due to the number of areas and conditions in which exploration and production can take place and to the fact that investors favor those offering the more attractive tax treatment. Tax competition is a fact of life in the extractives sector, as in any sector. International tax issues can also be expected to play a part in other ways, even if many of these are not peculiar to the extractives sector.2 Treaty shopping and transfer pricing can have significant impacts, especially in the context of resource-rich economies. Several web-based tools have been designed that have the potential to assist governments in addressing these fiscal design challenges. Some are mentioned at the end of this chapter. 6.2 KEY FISCAL OBJECTIVES
Ideally, the design of an EI sector fiscal regime should reflect objectives stated in a government policy document that sets
