Value Added Tax in the Extractive Industries

Abstract

INTERNATIONAL MONETARY FUND 5 and Mullins 2017; Sunley, Baunsgaard and Simond 2011). In their account of evolution of fiscal regimes for minerals, Hogan and Goldsworthy (2010, p. 127) briefly noted that many countries provide exemptions to encourage investment and ease the burden of administering large VAT refund positions due to the zero-rating of exports. More recent work, notably the United Nation's Handbook for extractive industries (UN 2016), provides for an overview of main issues faced by EI investors and key considerations for VAT design and administration. Similar discussion, with much focus on the implications of non-refunding VAT to EI investors, can be found in van Oordt (2019). Various country studies highlight alike problems with VAT implementation and its adverse impact on investment and production in extractive industries in Tanzania (e.g., Madzivanyika 2012). Madzivanyika and Kadenge (2015) evaluate the relation between VAT incentives provided to mining industry and the growing level of VAT refunds. While academic discussion on the VAT design in extractive industries is gaining momentum, there is consensus that a well-functioning VAT should not tax firms, while refund delays and VAT policy deviations can burden investment, impose large administration and compliance costs, and lead to revenue leakage. There is also consensus on the first best solution-treat the extractive industry as a normal business and provide timely refunds (UN 2017; van Oordt 2019). Some concede that in light of administrative weaknesses in paying VAT refunds some VAT concessions may be unavoidable (e.g., Sunley, Baunsgaard and Simond 2011). There lacks, however, systematic analysis on which VAT designs maximize government objectives when the refund delay issue continues to be a problem. One option is to replace the VAT with a Retail Sales Tax, but this is not recommended for efficiency and revenue-raising reasons (IMF 2002). 4 Policies that reduce input VAT (such as VAT exemptions or deferrals on imports) can mitigate cash flow issues but introduce undesirable incentives (including bias against domestic firms) and, therefore, administrative solutions may be preferred (van Oordt 2021). Nevertheless, the literature does not provide a robust qualitative and quantitative analysis of the trade-offs across alternative design options. This paper attempts to fill that gap. The overall objective of the paper is to identify, analyze and offer solutions to the most common VAT issues arising in extractive industries. While we fully subscribe to the consensus on the first-best solution, i.e., a broad-based VAT with timely payment of refunds, there appears to be no agreement on the second-best solution to a broad-based VAT in the literature or practice. Our analysis focuses on the impact of various VAT schemes introduced in response to the challenge of paying VAT refunds (as well as the cost of VAT refund delays). It seeks to establish which special VAT schemes are the least distortive and could be offered as a second-best solution to the general VAT regime and which schemes should be avoided. The discussion entails both qualitative and quantitate analysis, the latter based on the Fiscal Analysis for Resource Industries (FARI) modelling framework. While we touch upon some administrative solutions related to excess input VAT recovery, we do not offer a full account of issues faced by tax administrations in managing VAT in extractive industries. Neither do we take up issues related to public financial management, including those related to budget appropriations and escrow accounts. Our focus is primarily on policy solutions. 4 The VAT has a broader base, a built-in self-enforcing mechanism through to the credit-invoice system, and lower compliance costs for and greater revenue collection from smaller firms. The economic and practical advantages of the VAT are also illustrated by revealed preferences, as most governments use a VAT rather than an RST.