There are several downsides associated with RSCs. They transfer substantial risk to the state and, given the lack of performance incentives for a contractor resulting from the embedded service fee mechanism, they may result in significant efficiency losses. RSCs are not popular with investors because of the limited upside return allowed. This may explain why they are found only in states with resource bases that are substantial enough to offset the perceived disadvantages of the arrangement (Johnston 2003, 41, 61). Fiscal regimes applicable to other EI activities and ring-fencing
Other activities related to oil, gas, and mining—apart from the upstream EI activities related to exploration and exploitation of mines and petroleum fields, which are subject to the specific fiscal systems already described—are liable to the general tax legislation applicable in the jurisdiction at tax rates often lower than for upstream activities. These activities may deal, for example, with pipeline or railway transportation, gas-treating plants, oil storage and terminal facilities for export, liquefaction of natural gas plants, and refineries. The differences in taxation depending on the nature of activities explain why the upstream EI sector is in most countries ring-fenced from the other activities a company may have.
Selecting an appropriate EI fiscal system
In practice, the choice of a fiscal system will turn on contextual considerations such as tradition, political preferences, and existing institutions. Experience suggests that many companies are willing to work with the mentioned systems, whatever their types. There is, however, less enthusiasm for those contractual systems that do not permit them to book reserves under stock exchange rules, such as RCSs, or only a fraction of the bookable reserves under tax-royalty systems, as under PSCs. A crucial policy consideration is for the government to make sure that the complexity of the design of specific tax rules under a fiscal regime does not outstrip the state’s assessment, collection, and audit capabilities. It is also important that the rules are clear. Three broad approaches are possible. The first is to grow domestic capacity. The second is to limit the complexity of design to the capacity of the tax authority. Third, the country’s own tax staff may be supplemented with experienced international professionals and advisors who are fully able to administer a complex regime. The tax audit capacity is all too often the Achilles
heel of the tax administration. Above all, clear and detailed fiscal rules dealing with the specificities of the EI sector must be issued to limit fiscal uncertainties and facilitate smooth implementation of the regime. 6.4 MAIN FISCAL INSTRUMENTS UNDER A FISCAL REGIME
A wide range of fiscal instruments exists and can be found in fiscal regimes applied to mining or hydrocarbons projects. Some are common to all sectors in the economy, such as corporate income tax (CIT), customs duties, value-added tax (VAT), dividend or interest withholding taxes (WHT), employment taxes, income taxes, and capital gains taxation. Others are specific to the EI sector, such as mining or petroleum royalties, resource rent taxes or additional profits taxes, petroleum production-sharing mechanisms, bonus payments, and state participation schemes. In addition, specific EI tax rules may be necessary for each of the abovementioned instruments, such as for tax ring-fencing, CIT rate and depreciation, transfer pricing, carry-forward of losses, currency for tax returns, and so forth. For the investor, the overall tax structure and burden will be critical and more important than the particular tax instruments and rules a government chooses. For the individual government, the various instruments must be selected and combined in ways that fit the context or combination of circumstances. If, for example, there is low capacity or a record of poor governance, a combination of easy-toadminister instruments and limited discretionary power might be warranted. No two countries tax the extractive industries in the same way, which leaves plenty of scope for a researcher to differ on which is best among this “diverse and potentially confusing array of distinct fiscal regimes” (Smith 2012, 3). However, the primary mission of any trusted advisor when assisting a country in its policy is to explain and recommend the recognized best practice and help in designing the most appropriate fiscal package and terms for that country. Fiscal instruments can be individually evaluated against fiscal objectives, taking into consideration differences among the EI sectors, specific state circumstances, and institutional capacity. However, a fiscal regime uses several fiscal instruments in a combination constituting a fiscal package. The fiscal instruments in a regime interact, meaning that a piecemeal evaluation of individual instruments has limited value. For example, royalties may be a regressive instrument but may well have an important place as part of an overall tax and royalty system. The combination of all the instruments
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