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Proposal to Design Natural Resources Tax: A Reconstruction Fiscal Policy
toward Energy Resiliency in Indonesia
Haula Rosdiana, Inayati, Maria R.U.D. Tambunan
1. Background
The aim of this research is to describe tax liabilities and state levies shall be accomplished by oil and gas industries, specifically upstream business entities in Indonesia. In addition, the problems raise with regard to the fulfilment of liabilities will be also one of important highlight. Then, simpler fiscal policy to reduce administrative burden and to improve business friendly climate are the main considerations of reconstructing fiscal policy. Finally, this study will propose adoption of natural resources tax to simplify completion of business liabilities and ease the government to monitor business tax liablities.
Energy security is a crucial and critical issue for almost all of the country, because it will not only determine the existence of particular countries in global economy but it is also one of key factor for development acceleration. Phenomenon energy crisis disturbing government stability in several countries shall be lesson learned, and then determining energy security issue becomes priority on government program. In addition, countries which have abundant reserved energy (top 15 countries) such as Cina and USA still aggressively expands exploration projects in seek for new energy sources in other countries. It is driven by economic development and industrial activities which need high energy consumption, followed by government responsibility to ensure reserved energy availability until next 100 years. It also intended to reduce energy dependency on other countries. In fact, increasing trend of energy consumption in contrast with declining energy production happens (Rosdiana et. Al, 2015).
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Besides as instrument to promote energy security, oil and gas sector contributes significantly in Indonesia revenue although it is still fluctuative. In era Repelita1 I, contribution of oil and gas sector in Indonesia revenue was up to 27% of total national revenue. Then, in 1978/1979 contribution of this sector was up to 54% and its peak was in 1981/1982, up to 70%. However, the following years, its contribution has been going down until now2. In 2008-2012, for instance, the contribution oil and gas for government revenue was about 29,47%-20,75% with approximate 23,08%. In National Budget Revenue and Expenditure 2013, it has been predicted that oil and gas contribution on national revenue will be only 17,02% of total revenue3.
Further, income tax revenue from oil and gas enterprises increased about 13,5% per year in perode 2007-2011. Each of sector, income tax revenue from oil business entities contributes about 37,3% and from gas industries about 62,7%. Revenue from tax on oil and gas is also affected by ICP, discrepancy value betweem IDR-USD and oil and gas lifting Besides contribute to government revenue through income tax, this sector also contributes through state levies.
The fluctuation of oil and gas contribution on government revenue is caused by internal factor; reduction of oil and gas production and internal factor; fluctuation of international oil and gas price. Realization of Indonesia oil lifting in period 2008-2012 slightly increased, approximately 930,1 thousand barrel per day (2008), 953,9 barrel per day (2010). Start from 2011, the realization of lifting declined becoming 898,5 thousand barrel per day. In separated, based on information published by SKK Migas4, in period 2008-2011, realization of oil lifting tended to increase, 1.146 thousand barrel per day in 2008 then peak in 2011, 1.318 MBOEPD. However, the realization of oil lifting per day in the beginning of 2012 declined into 1.240 M Barrel Oil Equivalent Per Day (MBOEPD).5 Besides problem of oil and gas production declining, Indonesia technology availability to refine crude oil has not been sufficient. Therefore, GoI has to impor crude oil 350.000 barrel per day and ready to used fossil fuel 400.000 barrel per day.6 Besides negatively affect government revenue, these conditions will severe Indonesia energy security.
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Repelita I stands for Rencana Pembangunan Lima Tahun, the 1st era of President Soeharto became of Indonesian President 1968-1973
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National Budget Revenue and Expenditure 1992/1993
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Contribution of oil and gas sector on national revenue based on official government revenue and expenditure report 2014.
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Indonesian Oil and Gas Authority
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6 2013
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In order to solve the problem, the president instructed central authorities and local authorities through Presidential Instruction No.2/2012 to make effort to accelerate and maximize oil and gas production7. With regard to this sector, the characteristic of this sector which is “long time production process” and capital intensive shall be taken into account. Therefore, the role of private sector becomes considerable important. To attract investment, the government shall offer policy promoting friendly investment climate. One of important policy is state levies. Excessive state levies probably will increase government revenue in short term. However, in medium term and long term, this policy will be contra productive for national revenue because it will potentially reduce investment attraction.
Taking example from neighbour country which produce oil and gas such as Malaysia, it a has design programs toward energy sustainability that is known as Enhanced Oil Recovery (EOR). Besides high awareness of fossil energy availability, the government accelerate this program by offering fiscal incentives and marginal field project. In addition, the government also provides subsidy such as direct money transfer. All of the programs implemented by the government of Malaysia become consideration in determining this country as one of research sites to be a benchmark for Indonesia.
Impletemented tax policy on oil and gas industry is that shifting of high royalty then compensating it with low tax liability. Other feasible policy is intervention through production sharing contract (PSC) which allows mixed company (national and multinational) to run the contract. This business relation probably show stronger legal binding and transparent cooperation, different with regulation in the current production sharing contract; which is mixed company is represented by two types shareholders. The status of mixed company shall ensure basic protection of minority shareholders.
2. State Levies on Oil and Gas Industry in Indonesia
For the context of tax liabilities and other state levies, oil and gas industries, to be specific upstream industries are treated different with other industries since upstream shall be arranged under Production Sharing Contract (PSC). Most of treatment under PSC will be lex specialist to the general rules, including Income Tax Law in Indonesia and state levies. Through PSC, concept of cost recovery has been introduced therefore each cost/expenses bear to produce oil and gas will be reimbursed to the government as long as the expenses
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economically are related to the business process. All of the utilized asset on production process would belong to the government. Contractors will get return based on quantity of oil produced under agreement (PSC) with government.
A part from reduction of oil lifting, raised taxation problem; imposition tax on land and building potentially negatively affect investment climate on oil and gas industries. The stipulation of Government Regulation (GR) No.79/2010 regarding reimbursement of operating cost and taxation treatment on upstream oil and gas industries replaces regulation before, which implemented “assume and discharges” concept. The existence of “assume and discharge” concept allows the contractors have not to pay tax on land and building, it would be on government’s responsibility. Technically, Directorate General Taxation should pay the amount of tax payable to Directorate General Budget. However, GR No. 79/2010 regulates that contractors have to pay tax on land and building which is collected based on plan of development (PoD). Then, tax paid can be reimbursed to Directorate General Budget immediately after area of PoD has commercially produces petroleum and have getting approval from SKK Migas8. Therefore, contractor has to pay tax payable on land and building for each contract sign after stipulation of GR No. 79/2010.
Large amount of tax payable imposed from contractor before commercial years will tighten the cash flow during pre commercial years. In addition, upstream oil and gas industries are capital intensive and high risk industry that need huge of money. The study showed that failure risk during exploration is up to 70%-80%. It means when contractors fail to find a potential hole, they have to pay tax in advance which can be reimbursed. This situation will be difficult for contractor to set business forecasting. In 2013, SKK Migas reported that 12 contractors lost 1,9 milliard USD because they only found dry hole in 16 exploration bloc. Further, the numbers of contractor relinquish PoD to the government immediately while bidding process in 2013 because of high fiscal costs. It was indicated by only 37,5% of contractors run the contract in the first round 2013. It is far lower compare to years before which was up to 90%.
Importantly, high fiscal cost caused by tax on land and building before commercial stage will adversely affect not only availability of energy, specifically oil and gas in Indonesia but also other government revenue through corporate income tax on upstream industry. With regard to this problem, therefore it need to redesign appropriate tax policy
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which accommodate business process and business risk in this sector without abuse government potential revenue.
3. Reconstructing Fiscal Policy: Adopting Natural Resources Tax in Indonesia
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Graph 1
Cost of Production Process on Upstream Industries
Source: Sudjati Rachmat, Jenis-jenis Pengusahaan Hulu Minyak dan Gas
Similarly, following the study of Nakhle (2010), he highlighted most issues cover taxation policies for petroleum business which put specific character of upstream business and complexity as important consideration. Different with other industries, the upstream business come to a country because of its natural resources. Therefore, the certainty of agreement component and strong support of government in location or country invested is critical. They cannot move immediately their business like factory industry for example. Unfortunately, sometimes even though upstream industry in its characteristic has international common practice in operational and production process, the local or location of operation in a particular country may take a part in influence or shaping in the decision of tax treatment. This fact cannot be blamed negatively influence the attractiveness of investment.
High risk, less return less risk, high return
CUMMULATIVE
INVESTMENT RISK
Geology risk
Natural risk
Economics risk
Technical risk Political risk
Exploration
Finding
Investigation Development Development study
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The uncertainty of initial investment associated to upstream industry that is the cost of petroleum project by its risky nature has to incur up front. Then, the time lags are critical since it often will take of many years and even decades for one project, from the initial discovery of oil or gas reserves to the time of first production (commercial stage). Moreover, imposition of petroleum taxes and the involvement of the private sector in oil activity tend to be accompanied by intense political debate where political dogma and related stakeholder interest can overshadow economic principles.
Similarly posed by Boadway (2010) that series of process consisting of discovering, developing, exploiting, marketing/selling and closing an oil field/bloc can cost a lot of money and needs years. In oil and gas, it is common for 50 years or more to pass throughout the process from the exploration until rehabilitation stage. Moreover, the associated expenses in large proportion have to bear in early of projects for year in which stability of cash flow is critical; the limited sunk cost in the beginning shall affect the whole process whereas only little alternatives probably can be taken to cope with this process. It may happen that if an offshore oil platform may be moved to other field or other countries, for example, but the amount of cost spent looking for or exploring potential oil fields successfully or not is gone. A different of cost acquisition of getting fruitful initial production process, significant sunk cost are probably incurred in other lines of business too, for example in developing power plan may be business entities have to undertake R&D, as the analogous to exploration spending, or on pharmaceuticals have conduct series of research– however, their pervasiveness and magnitude in resources activities put them at the central of the problem of sectoral tax design,.
Similarly, it is also stressed by Nakhle (2010) that the perception of oil field competitiveness is also affected by the design of tax regime although it might not be in the first place of competitiveness consideration. An easy tax structure and friendly tax administration process may recapture or be a bit balancing other problems potentially raised as the result of exploration process, development activities, technical, financial or probably political problems in location. It may also show a supporting position of government in respect to the producing process and contribution of oil companies for the supply of domestic energy availability.
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with other countries will be critical for both of them before signing the contracts. The common practice/international best practice shall give another view of levying or shaping tax burden. When the outcomes of negotiation process between then show mutually benefit, both of them will enjoy sharing reward and will maintain more sustain economic relation in long term.
In separated part, it is perhaps can be said that if the tax regime is too favor, the government will be in weak position in which the investor may utilize it to maximize rent seeking potential, then the return taking by government probably will not as it should be. If the tax treatment and state levies are too complicated, then the incentives offered to contractors (upstream business) to invest in exploration stages, development process and production process in reality cannot lessen the burden then worsen by uncertainty rule of law, it can be severely damaged then as the result, the investors will be inflow their capital into the countries offering a more attractive fiscal regime and more friendly investment climate.
For the context of Indonesia, imposition of tax on land and building for upstream contractors immediately on the exploration process seems unusual. Even though the cost bear for paying tax on land and building is reimbursable through cost recovery, upfront cost in initial process shall tighten the cash flow in the stage when the investors have to spent huge money. In addition, the recovered cost in which tax payable on land and building consisted can be back once the investor has reached commercial/ economic stage. This treatment will be disincentives for investors (which are mostly private) while Indonesia has not has sufficient resources to engage in their own upstream process. International best practice in levying taxes, specifically tax on land and building need to consider that most of the countries do not impose tax on land and building on upstream company. Several examples of state levies and tax treatment on upstream can be seen in the following table.
Table 1
Tax Structure and State Levies in Several Countries
Country Fiscal Treatment
Malaysia Malaysia regulate tax scheme and state levies on upstream oil and gas industries through Petroleum Income Tax Act (PITA).Exploration and exploitation projects are exclusively undertaken by National Oil Company (NOC) Petronas. Other private willing to take a part in upstream shall go into agreement through Production Sharing Contract (PSC) or Risk Sharing Contract (RSC) with Petronas.
State levies and tax schemes:
a. Royalty 10% from gross profit
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Development Area (JDA) first 8 year 0%, second 7 year 10% and rest 20%
c. Income Tax 25%
d. Real property tax (per 1 January 2014):
30% of net profit after 3 year of commercial operation
25% of the 4th year
Secondary recovery 40% 10%
Any other cases 20% 8%
Fixed, offshore platform nil 10% Environmental protection equipment facilities 40% 20% Computer software and hardware 20% 40% Building
Secondary recovery 20% 3%
Any other cases 10% 3%
Thailand Regulation regarding imposition of tax and state levies in Thailand can be categorized into 3 term:
a. Thailand I, royalty 12,5% from total sell, petroleum income tax 50% from net profit
b. Thailand II,
Royaty 12,5% from total sell
Yearly net profit (concession agreement is considered)
Yearly bonus (concession agreement is considered)
Petroleum income tax 50% from net profit c. Thailand III
Royalty, 5%-15% based on amount of product per bloc basis
Special remuneration (yearly basis) 0%-75%
Petroleum income tax 50% from net profit Capital allowance offered by the government
Assets % per year Cost of acquiring concession and petroleum reserves 10% Cost of acquiring concession and petroleum reserves 10% Cost of acquiring lease rights:
No agreement or renewable Limited lease period
10% Lease period Other capital expenditure not mentioned above:
Tangible capital expenditures
Capital expenditure for deep sea exploration blocks (deeper than 200) meters
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Philippine State levies and tax schemes applied in Philippine shall be according to Production Sharing Contract (PSC):
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Bonus in signing the contract
Income tax 30% as general provision
Contractors are eligible for capital allowance and investment incentives
Laos PSC contract in Laos does not regulate kinds of business liabilities such as signature bonus, royalty. Provision of production sharing is as followed:
Daily average product
Australia Australia combines several regulation regarding income tax, petroleum resources rent tax and royalty based tax on upstream business. Provision of levies is as follow:
Royalty 0%-12,5%
Income tax 30%
Resource rent tax 40%
Government undertake different treatment for those underside under Australia business law, they shall be imposed Capital Gain Tax (CGT) and taxable Australia Property (TAP):
Property tax covers area which solely produce deposits
Indirect Australian Real Property Tax for specific case
Germany Germany does not impose specific tax on upstream. Simple tax liabilities shall be paid by contractors:
Income tax, approximately 29,*%
Royalty 0%-40%
Bonus does not apply
Before examining further to the probability of designation of natural resource tax, it is important to know the fundamental aim of imposing this specific tax. Land (2010) stated that the aim of imposing natural resources tax is to enable government having reward of potential revenue which cannot be captured solely by the preliminary contracts because of possibility of unpredicted richer resources. The strong definition by citing the fundamental concept of
resource rent tax is “the ex-post surplus of the total project lifetime value arising from the exploitation of a deposit, in present value terms, over the sum of all cost exploitation of a
deposit, in present value term, over the sum of all costs of exploitation, including
compensation to all factor of production” (Land, 2010, 245).
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with royalty and corporation tax. The resources rent tax may either be used as final tax
levied on after-tax cash flows or as supplementary levy on pre-tax income, payment of which
would be deductible for corporation tax purpose (Land, 2010, 252). In simple way, it can be said that natural resources tax shall be capture the fairer way of tax burden paid by investors and the appropriate revenue received by the government. In its implementation, for example taking case in Papua New Guinea, the design of natural resources tax is used to seek the attractiveness of new investment.
In addition, in designing tax on natural resources, tax system should be done in more flexible way. The premises of this is that the cost of extraction may different throughout the process, the deposit is extracted under dynamic price, the greater potential benefit from the basin, the more earned by the government. In vice versa, for the high risk extracting projects, the government may get less revenue. In ideal context, fiscal treatment for contracts/ agreement shall be more specific and flexible (Land, 2010). In principle, natural resource tax enables the government to capture resources from deposit without deterring the investment. The following is the comparison of resources tax with other taxes on profits.
Table 2
Comparison of Resources Rent Tax with Other Taxes
Government “take” link to Government “take” responsive to:
Reserves or production
Price change Costs Timing of cash flows
Cost of capital Production (daily cumulative) yes no no partly no Example: company share of profit oil is 50% at low output falling to 15% high output (Uganda) Price (price caps or base prices) no yes no partly no
Example: oil profits taxed at 25% until oil price exceeds USD 30/bbl, thereafter rising by 0,4% for every USD 1/bbl > USD 30/bbl (Alaska, USA)
Annual profit
(profit margin or return in a tax year)
yes yes yes no no
Example: mine taxable income is taxed at the higher of 25% or 70-1500/x where x (%) = taxable income/gross income; the higher rate applies when x > 33,3% (Botswana and Uganda; South Africa and Namibia employ the same scheme with different value in the numerator)
Example: mine after-tax profits taxed at a rate of 0-15% once return on capital employed > long term bond rate + 5% (Australia mining agreement)
R Factor
(revenue: cost ratio or investment multiple)
yes yes yes partly partly
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net income to total investment (India) Resource Rent Tax
(Rate of return)
yes yes yes yes yes
Example: petroleum after tax cash flow taxed at 40% once the project internal rate return exceeds the long term borrowing rate plus 5% (Australia)
Source: Source: Bryan C. Land, (2010), Resource Rent Tax: A re-appraisal page 252
For Indonesian context, imposition of tax on land and building seems violate principle of natural resource tax, because in its implementation, it seems does not consider life time value, present value and discount rate of project by simply imposing tax on land used in exploration process, seems like property. In addition, for risk consideration, the difference treatment between one contract and others seem could not be reached.
When a country intends to design natural resources tax, Land proposes that they shall keep in mind 3 fundamental element of designing natural resources tax (i) specific rates of return on investment that trigger the imposition of the tax (ii) specific tax rates imposed on net profit once the rates of return has been exceeded and (iii) the tax base which is typically an individual resource project and allowable deduction.
Several important consideration and challenges need to think of in designing resources tax regimes as proposed by Boadway and Keen (2010); (i) a discount rates and their implication, (ii) risk sharing (iii) responses to asymmetric information. With regard to discount rates, for such long projects, the discount rates applied by government and investor – difference calculation between them can play a critical role. For the investors, the discount rate may describe cash flow during the process and potential risk is captured through cost of capital. Importantly, the number of discount rate commonly is different across the countries because of the different activities and potential risk. In principle, companies’ discount rates should reflect and give understanding to the shareholder of potential risk they face and potential gain they can get on their portfolio and assets. This also should reflect the ability of government in host country commitment to support existing projects and tax regime applied.
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putting time consistency issue of project completion. This imaginary result shall enable the government to commit credibly in prescribe tax schedule. The tax schedule could take any shape: it might be progressive with a higher average tax rate in the more successful the project or it could be regressive based on project potential return.
Finally, responses to asymmetric information. Policy makers shall also consider potential difficulty of being less well-informed on aspects covering the process, for instance information about the geological and commercial circumstances of resources project than are being implemented. The response of government in undertaking of the project shall be the thorough examination of potential unbalance information that has been covered through tax schemes in acceptable way of business. Several considerations need to think of as criteria and indicators in evaluating policy before designing appropriate policy:
Table 3
Evaluation Criteria and Indicator in Designing Natural Resources Tax
Evaluation criterion Key Indicators Type of sample or output neutrality Average effective tax rate
(government take in profitable case) Revenue raising capacity Time profile of revenue
Share of rent to government Tax share of total benefits
Price just yielding investor’s discount rate
Investor perception of risk Dispersion of expected IRR Probability of below-target
Compare expected yield index with expected risk index
Probability distribution of cases
Prosperity gap Present value to equalize mean PV to investor
Present value to equalize PV of negative return
Probability distribution of cases
Source: Daniel Philip et. Al (2010), Evaluating Fiscal Regimes for Resources Projects, page
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Table 4
Details of Resources Rent Tax in Selected Countries
Countries Single
Source: Bryan C. Land, (2010), Resource Rent Tax: A re-appraisal page 259
4. Conclusion
Regulation on imposition of tax and other state liabilities on upstream industry shall consider its business characteristics; high risk and capital intensive. High tax burden in exploration
stage (non commercial stage) probably will severe business’ cash flow, moreover if the country apply cost recovery system in which abuse “assume and discharge” system.
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to consider as an alternative. In the designing appropriate tax scheme, the government should adopt its policy choice into principle of natural resources tax.
5. References
Boadway Robin, (2010), Theoretical Perspective on Resources Tax Design, New York: Routledge International Monetary Fund.
Boadway Robin, (1993), The Taxation of Natural Resources: Principles and Policy Issue, Working Paper Policy Research Department International Monetary Fund
Daniel Philip et al., (2010), Evaluating Fiscal Regimes for Resource Projects: An Exmple from Oil Development, New York: Routledge International Monetary Fund.
Hogan Lindsat and Goldsworthy, (2010) International Mineral Taxation: Experience and Issue, New York: Routledge International Monetary Fund.
Land Bryan C. (2010), Resource Rent Tax: A-Reappraisal, New York: Routledge International Monetary Fund.
Mullins Peter, (2010), International Tax Issue for the Resources Sector, New York: Routledge International Monetary Fund.
Nakhle Caroline, (2010), Petroleum Fiscal Regime: Evolution and Changes, New York: Routledge International Monetary Fund.
