Confronting The New Trends In Extractive Revenue Leakage,By Kolawole Banwo
The exploration, exploitation and marketing of natural resources require enormous financial and technical investments. Hence although governments in resource-rich countries own these resources and are expected to manage (them) on behalf of and for the ultimate benefits of their citizens, they are compelled to enter arrangements with parties that will facilitate the development of the resources. This usually come in the form of contracts with exploration and production companies most of which are privately owned and controlled though publicly quoted with limited liability. According to Petroleum Intelligence Weekly’s (PIW) ranking in 2010, of the ten biggest oil companies in the world, four were state owned while six were publicly quoted. These were also usually multinational companies with parent companies in one jurisdiction and incorporated subsidiaries in several others. The pattern for oil and gas exploration in Nigeria is no different from this.
From 1958 when British Petroleum held sway to the current scenario with several players in the industry, the dominant firms namely ExxonMobil, ConocoPhillips, Chevron, and Royal Dutch Shell, Total, etc are multinational companies with which the Nigerian Government have entered into various forms of contracts. As will be expected, revenue is central to every contract. Indeed, Nigeria has come to depend on oil and gas for over 85% of its revenue. The oil and gas Policy of Nigeria for instance, states that the fiscal regime for the upstream shall ensure that maximum revenue accrues to Government from Oil and Gas activities while also guaranteeing a reasonable return on investment. If this is juxtaposed with the basic definition of business which is the preoccupation of investors who create the corporations that become oil firms, which is to engage in activities for the purpose of making or maximizing profit, the picture of mutual benefit but conflicting aspirations, emerge. This is because increased revenue for the host government erodes the profit of the oil firm and vice versa. This is why the fiscal regime is crucial for both governments and companies and dominates the tune of any contract for resource exploration and production as they delimit and define the amounts of profit and economic rent that will accrue to each party throughout the life of the contract. Striking a balance between maximizing revenue and profit is a product of continuous negotiations and search for balance. The result is the enactment of policy and legal frameworks by governments and experimentation with diverse forms of contractual and concessionary arrangements as they seek to maximize government take without overbearing risks and responsibilities or creating disincentive to investment and repel the oil firms. Similarly companies employ various methods to position themselves to maximize profit and justifying the risks by their stakeholders without forfeiting opportunities. These have sometimes being pursued using unconventional means.
Maximizing revenue for government requires preventing leakages. Maximizing profit for firms is impossible without minimizing cost. It is in this context that the fiscal instruments employed become critical. The Fiscal regime in Nigeria is made up different instruments. Some are single one off pre-production payments like bidding/licensing fees, Signature Bonuses, others like royalties, are post-production while others still are dependent on profit. These include the equity oil in Joint Venture Agreements JV and profit oil in Production Sharing Contracts, PSC and the petroleum profit tax, PPT.
Due to the financial burden placed on government funds by cash calls required by the Joint Ventures, the Nigerian government has gravitated towards the contractual arrangements like the Production Sharing Contracts, PSC. This make the Oil Company to bear all risks and raise all investments but recover cost upon commencement of production. The fiscal terms in the PSCs broadly, provide for Royalty Oil, Cost Oil, Tax Oil and Profit Oil. The arrangement allows the oil company to recover cost before tax and profit. This arrangement makes Nigeria vulnerable to revenue leakages. It is generally agreed that unless revenue and other regulatory agencies are well trained, equipped and vigilant to monitor cost effectively, Nigeria will suffer revenue loss and several examples confirm this assertion.
This has become more challenging with increasing complexities in the operations of multinationals, diversification of operations through the use of subsidiaries, upsurge in intra-firm trading and creation of complex transaction across multiple jurisdictions, including those notorious for secrecy. Effective oversight and verification of financial transaction of international oil companies have therefore become difficult. Furthermore, many multinational companies are adept at using controversial techniques to significantly reduce perceived profits. They create subsidiary companies to act as the ultimate owners of brands and assets in opaque jurisdictions like the Netherlands, pay large management fees by revenue producing companies in one country to another group company that is based in a tax haven, shroud revenues made by a revenue generating company through inter-company trading activity , a practice known as transfer pricing and engage in thin capitalization through intra-company loan repayments at exorbitant rates, if no effective check is out in place. The effect of this is to shift profit which in turn means they pay less tax in revenue generating countries for which enforcement of tax laws, capacity to prevent, detect and sanction erring firms are relatively low.
In order to ascertain the tax payable by a company in Nigeria, the following computations are necessary: Revenue Adjusted Profit, Assessable Profit, Capital Allowances, Chargeable Profit, and Assessable Tax. Certain components are are heavily dependent on cost accountings which are dependent on company records and an audit process that requires complicated computations and maintenance of diverse sets of records. There have been recorded cases of self assessment by firms. A survey by the Tax Justice Network in 2011 revealed that Chevron is the most opaque extractive industry company in the world with 47 of its 77 subsidiaries registered in secrecy jurisdictions. It is followed by ConocoPhillips and the Exxon. Secrecy Jurisdictions, tax havens or offshore financial centres provide financial environments that allow lower tax regimes, offer anonymous bank accounts, keep records and beneficial owners of commercial activities secret and criminalizes the divulging of information related to financial transaction involving individuals and foreign companies.
Such jurisdictions are therefore used for the movement of illicit financial flows from other jurisdictions. These include proceeds of bribery and theft by government officials; criminal activities including drug trading, human trafficking, illegal arms, contraband and more; and commercial trade mis-pricing and tax evasion. The latter is by far the largest, and is believed to comprise two thirds of the total amount of illicit flows that cross the borders into secrecy jurisdictions undermining the ability of resource rich countries to maximize revenues for their natural resources and they constitute leakages many times unnoticed.
It is a well known fact that MNCs, in their bid to maximize profit can adopt any means to evade or avoids the payment of tax. It would be recalled that in 2008, the then president Yar’adua ordered that the sum of $414.6 million accruable to NNPC and to government from Bonga gas sales and as tax revenue from the gas sales should be recovered from Shell and ExxonMobil. Earlier in 2006, President Obasanjo had also ordered the recovery of $340 million in short falls from data extracted from Tax returns filed with the federal Inland Revenue Service from Shell, Mobil, Chevron Nigeria, Nigeria Agip Oil Company (NAOC), Texaco and Elf. Previous Audit reports by the NEITI have revealed that much. Recently on December 18, 2012 four former employees (British Nationals) of Technical Energy Solutions were charged in a London court for conspiring to bribe tax officials in Nigeria to lower tax liabilities between 2008 and 2009. The bribe paid was to avoid, reduce or delay payment of taxes on behalf of oil and gas industry workers sent tin Nigeria by Swift. These indicate that the level of tax compliance among IOCs is questionable.
Tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes. Today, over 60% of world trade is taking place within transnational companies, such as the extractive industries. This gives room for transfer pricing which though a legitimate business transaction, is subject to abuse leading to mis-pricing which is used to reduce tax liabilities. The practice also facilitates capital flight, tax avoidance, import duty and VAT avoidance. The US loses around $100 billion of tax revenues each year from offshore avoidance schemes. A report in 2011 indicated that between 200 and 2008, Nigeria lost $130 billion in illicit financial outflows making her the largest source of illicit outlows in Sub-Sahara Africa. It is logical to postulate that most of these emanate from the extractive secto
Another insidious occurrence that undermines resource revenue is the increasing concern about the roles played by some players in the financial sector in facilitating leakages in revenue from resource rich countries in developing countries. Banks and accounting firms have come under intense scrutiny in the developed world. It has been established for instance that the dominant accounting firms in the world have introduced the production of non audit services to their clients (MNCs). Christened tax financial advisory services, financial consulting or tax planning, they have grown much faster than the audit business in recent years. For instance, in the 2012 fiscal year, one of these firms increased its revenues from consulting by 13.5 percent and from financial advisory by 15 percent compared with 6.1 percent for audit and 3.9 percent for tax and legal services.
In developed countries like the US and the UK where the capacity exists, these services have increasingly been unmasked as tax avoidance or tax dodging schemes resulting in loss of enormous revenues. The UK is estimated to be losing around £100 billion of tax revenues each year while the US Treasury is estimated to be losing between $345 billion and $500 billion of tax revenues each year through these schemes. MNCs pay huge amounts in exchange for these services. For private companies who seek to maximize profit by being cost effective and devising cost saving strategies, to be willing to pay huge sums to financial firms in exchange for tax planning, it implies that the benefit exceeds the cost.
In 2005, an internal study by the Her Majesty’s Revenue and Customs (HMRC) concluded that four UK-based accounting firms generated around £1 billion in fees each year from “commercial tax planning” and “artificial avoidance schemes”. It is interesting to note that these accounting firms operate in Nigeria and are favourites for the mandatory audit of major firms, including MNCs, as well as undertaking consultancy for government. It would be interesting what an investigation into their activities would reveal. It is pertinent to state that tax avoidance is not traditionally illegal and independent nations have the right to determine what financial policies they adopt, but unfolding events that confirm that they do damage to the economies of other countries and undermine the international economic system had made nations rise to oppose and criminalise their activities with a bid to mitigating the effects of their activities of the bares minimum.
The challenge of this emerging issues is that the conventional EITI criteria and standards, though useful do not effectively address them as the accounting standards used are strictly adhered to and the financial information required are made available. The financial information required in public domain to provide multiple stakeholders sufficient information for comparisons and interrogation exceeds the current EITI reporting standards. The level of disclosure required by the Dodd-Frank Act in the US is an improvement as it adopts a limited version of country-by-country reporting. However, the detailed disclosure of accounting information that will make both figures and their derivative parameters available to third parties in what is referred to as the extended county-by-country reporting as advocated by the Publish what you pay movement provides the most formidable deterrent to financial secrecy by MNCs.
The extended country-by-country reporting requires IOCs to disclose detailed accounting information among which are: The name of each country in which it operates and in which it has a permanent establishment for taxation purposes, the names of all its companies trading in each country in which it operates, details of the cost and net book value of its physical fixed assets including the cost of all investments (including those relating to exploration) made in assets related to extractive industries activity by location, details of gross and net assets in total for each country in which the entity operates and the total sum actually paid in respect of the taxes.
The companies are presently not disposed to this level of disclosure for reasons that are untenable. Stakeholders, especially civil society must continue to advocate for increased transparency in this direction. Legislators in developing countries must also begin to interrogate relevant domestic legislations that can be employed to compel iOCs operating within their jurisdictions to adapt more transparent and open practices that undermine their domestic revenues needed for development. Laws regulating the activities of financial and legal professionals, financial service providers and intra firm trade practices must be re examined and strengthened. Relationships with firms registered in secrecy jurisdictions should be reviewed while international collaboration especially within the south should be intensified to build formidable, bi-lateral and multi-lateral partnerships in confronting the strong forces in the North who aid and abet commercial enterprises that perpetrate these illicit flows of tax avoidance and evasion to benefit their economies and facilitate corruption
Developing resource rich countries like Nigeria must strengthen its institutions, develop the capacities of its revenue agencies and pursue the enactment of relevant legislative and policy frameworks to facilitate the prevention, detection, prosecution and effective sanction of firms that are engaged in underhand activities such as tax evasion and avoidance, transfer mis-pricing, profit shifting, thin capitalization, to deny the people of much needed resources for development. In a recent briefing of members of the national Assembly for relevant Committees for Petroleum UpStream and DownStream, Solid Minerals, Public Accounts and the leadership of the Nigeria Extractive Transparency Initiative, NEITI, this writer drew their attention to these developments and advocated that in their consideration of the draft Petroleum Industry Bill, PIB, presently before them, they should consider incorporating transparency clauses that will reduce these practices. One of the lessons learnt from a recent Conference organized by the Publish What You pat, PWYP Norway, was a unanimous position by several of the speakers, that enacting an overarching legislation with such provisions is more effective in preventing the operations of firms with links with secrecy jurisdictions than leaving it to the negotiation of production contracts as they tend to wield greater influence and have strengthened negotiation positions at that level. The PIB is a strategic and good place to start.
Kolawole Banwo,Snr Programme Officer, Civil Society Legislative Advocacy Centre, Abuja