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Should the OECD’s Proposal for a “Unified Approach” on Corporate Taxation Exclude Extractive Industries?

 Key messages
  • The OECD’s “pillar 1” proposal introduces a new allocation of multinational profits of consumer-facing businesses based on sales.
  • If member countries of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting adopt this proposal, they should exempt extractive industries so as to protect the legitimate interests of resource-exporting countries.
  • If they developed a different formulaic approach to reallocate profits based on factors other than sales, which would be arguably more favorable to developing countries in general, then it could be in the interest of resource-exporting countries to include the sector, or certain segments of it.
 
Last month, the OECD Secretariat invited comments on a proposal for a unified approach under the first of two pillars of an international effort to reform multinational corporate taxation. These measures had been agreed by more than 130 countries that are part of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). They have agreed to implement a number of tax avoidance and information sharing mechanisms (BEPS actions), monitored by peers, and will be negotiating the details of the two proposed pillars in the coming year. This reform initiative is detailed in a Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy, published earlier this year.
 
The sponsors of the initiative have focused on multinationals with business models closely linked to the digital economy (e.g. Facebook, Google and Amazon). But some participants hoped this would also be an opportunity to tackle broader issues with existing global tax rules. Many experts agree that the international rules to tax multinational businesses developed a century ago and based on the “arm’s length principle” are not suited to today’s globalized supply chains. This consensus extends from activists who have campaigned on this platform for many years, such as the Tax Justice Network, to international financial institutions like the IMF.  
 
Debates around global tax reforms, whether in the current initiative, or its predecessor the G20/OECD BEPS project have not generally focused on extractive industries. If anything, the project’s “programme of work” anticipated carve-outs for specific sectors or industries, including for oil, gas and mineral extraction. These industries are inherently linked to the location of subsoil assets, which are in most cases owned by governments of the relevant countries. There is therefore little debate about the rights of “host” countries (those where commodities are sourced) to tax these activities. There are actually very sophisticated fiscal regimes dedicated to the sector in these countries, with specific instruments like production-based royalties and rent taxes, usually alongside more broadly applicable instruments like corporate income tax.
 
However, these distinguishing factors don’t mean the sector is immune to tax abuses. There are many examples of oil, gas or mining companies over-relying on tax incentives or related party loans, treaty-shopping, manipulating mineral sales and input costs, and using complex international tax rules and tax havens to their advantage. Some of these problems can be addressed with current BEPS actions, with sector-specific, often country-based regulatory reforms. But the current international reform initiative could bring stronger fixes to enduring tax challenges in the extractive industries.
 
The OECD Secretariat proposal under “pillar 1” targets consumer-facing businesses, beyond the original focus on highly digital business models. The proposal consists in dividing corporate profits between routine and non-routine profits, and then reallocating part of the non-routine profits to market jurisdictions, based on sales (so-called “amount A”). The proposal also includes the possibility of a fixed remuneration for marketing and distribution functions of multinationals (“amount B”), for tax purposes, and binding dispute resolution mechanism between taxpayers and the tax administrations of market jurisdictions (“amount C”). The members of the Inclusive Framework will have to agree on the proposal and negotiate the complex details, which will determine the impact of “pillar 1” reforms for developing countries.
 
The OECD Secretariat suggests that the extractive industries would be out of scope of the current proposal under “pillar 1”. For good reason: its proposed reallocation of taxing rights based on the location of ultimate sales would go against the legitimate right of resource-rich countries to get the full economic compensation for the extraction of their subsoil assets. Companies in the sector know that payments to host countries are a key element of their “social license to operate,” and that the application of current proposals under pillar one could increase their overall tax burdens, and create instances of double taxation and conflicts with host country jurisdictions. Individual extractive companies and industry bodies have therefore made multiple submissions to the OECD Secretariat to provide arguments for a sector carve-out. The African Tax Administration Forum and  Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development have made similar requests, voicing the interests of resource-rich developing countries.
 
However, how a carve-out would work in practice may create new complexities. Should it include the whole value-chain or just extraction rights? Should it apply to suppliers and contractors? What about businesses with extractive and non-extractive activities in their portfolios? This points to a serious limitation of the current proposal, highlighted by many other submissions which are not directly concerned with extractive industries. Oxfam, the Tax Justice Network, the South Center and a number of other submissions all argue that the proposal is too complex, not universally applicable, and biased against developing countries. The new profit allocation rule only includes sales, which favors large consumer markets in rich countries and emerging economies, rather than assets, employees or user base, for instance. These commenters argue that the international community should discuss different formulae that would be both easier to implement and more universally applicable. If one of these alternative proposals prevailed, it could conceivably mean that parts of the extractive sector (e.g., processing activities, nonresident suppliers, commodity traders) could be included in the scope of a formulaic apportionment of multinationals’ profits. If a specific “extraction factor” were added, it may even be in the interest of host countries to adopt a global formulary apportionment of profits. The Alaska state revenue authority applies such an extraction factor to the oil and gas sector to compute state-level income tax.
 
While the debates on pillar 1 continue, proposals for pillar 2 are already on the table. Under the name global anti-base erosion (GloBE), pillar 2 proposals include minimum taxes on outbound investment and rules on base-eroding payments. The former would be relevant in countries where multinational companies are located and discourage tax competition from other residence countries and tax havens. The latter would give more rights to countries of operation to tax income in their jurisdictions, by denying deductions for (or adding a withholding tax on) payments to nonresident related parties that were not subject to a minimum tax.
 
GloBE proposals are more likely to apply directly to extractive industries, and depending on their design could have a positive impact on the ability of resource-rich developing countries to more effectively tax multinational oil gas and mining companies. It will be important for NRGI and other independent actors focused on extractive fiscal regime design to position themselves on the debates and the implications of reforms eventually adopted by the international community.
 
 
Thomas Lassourd is a senior economic analyst at the Natural Resource Governance Institute (NRGI). Thomas Scurfield is an Africa economic analyst at NRGI. 

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