EI Sourcebook | 7.4 Fiscal Packages

7.4 Fiscal Packages

Fiscal Packages^[40]

Given the multiple objectives of fiscal design, fiscal regimes invariably are constructed as packages, including several elements. Two of the most popular packages are the tax and royalty package and the production sharing package. Both packages may include state equity participation. Both packages are found in the petroleum industry. Tax and royalty regimes are dominant in mining.

Tax and Royalty Packages. Tax and royalty fiscal packages may involve a corporate income tax, a modest royalty, and an additional charge to achieve progressivity and capture rent. It contrasts with production sharing packages, which include a sliding scale of production payments for progressivity, and a corporate income tax. It is important to recognize that the two packages or regimes can be structured to be exactly equivalent in fiscal terms – what matters in their detailed content, not the label attached.

Production Sharing Packages. Production sharing fiscal packages may include many of the same types of fiscal design as tax and royalty packages; the major difference between the two packages is that production sharing packages give the state a percentage of actual production in addition to any taxes or royalties that may be collected. Since the state receives a percentage of production, the taxes and royalties will typically be lower than under a tax and royalty system.

Service Agreement Packages. A third EI sector package, but much less common, involves payments by government to the contractor rather than payments by the contractor to government. Under these risk service contracts (RSCs), companies perform a specific task in exchange for an agreed fee which may be a fixed sum or a fixed return on investment in a project. RSCs are not widespread.^[41] They are largely confined to Mexico and a few Middle Eastern states. Governments using RSCs see them as transferring maximum rents to the state.

A crucial policy decision is for the government to make sure that the complexity of the design of its fiscal regime does not outstrip the assessment, collection, and audit capabilities. Two broad approaches are possible. One is to limit the complexity of design to the capacity of its tax authority. The other is to supplement its own tax staff with highly experienced international professionals who are fully able to administer a complex regime. In this regard, the tax audit capacity is all too often the Achilles heel of the tax administration.

Topics also deserving special attention include: (1) alignment of tax policy or design with administrative capacity; (2) effective performance of routine and non-routine functions; and (3) institutional structures.

There are, however, a number of downsides associated with RSCs. They also transfer substantial risk to the state, and given the lack of performance incentives they contain 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.^[42]