Mongolia’s missing mining taxes

The extractive industry in Mongolia is making huge money for multinationals, but tax avoidance means this wealth is not translating into investments for the country’s public services.

Mongolia’s economy depends heavily on extractive industries. The vast and landlocked country possesses large reserves of coal, copper, and other mineral resources. The mining sector accounts for 80 per cent of total exports but generates only 20 per cent of national budget revenue.

The biggest and most controversial project is the Oyu Tolgoi (OT) mine located in the southern Gobi region. The copper and gold mine is ultimately owned by Rio Tinto, with Mongolia holding a minority stake. Among other issues, the company is under scrutiny by a parliamentary working group as well as a critical civil society regarding its tax practices, possible tax avoidance, and tax deals it made with previous Mongolian governments.

Vincent Kiezebrink, researcher at the Centre for Research on Multinational Corporations, was part of a team that conducted a thorough analysis (link) of what they believe are elaborate tax avoidance schemes and tax incentives provided to Oyu Tolgoi that led to nearly 700 million US dollars in lost taxes for Mongolia and Canada.

How big is the issue of tax avoidance schemes by multinational corporations in extractive industries on a global scale? In what way should we be concerned?

Vincent Kiezebrink: On a global scale, lost tax revenues due to corporate tax avoidance is estimated at between 200 billion and 600 billion US dollars per year. This should concern us because it limits the world’s governments to invest in public services, or deal with global crises like climate change, thereby negatively affecting society. Research has shown that tax avoidance proportionally does most damage to developing countries, like Mongolia. These are the countries that most need increased tax revenues to be able to provide public services to their inhabitants.

Finally, tax avoidance has played an important role in the rise in inequality the world has seen since the 1980s, allowing the wealthiest in society to increase their wealth by limiting what they contribute to state coffers.

How do these tax avoidance schemes usually work?

VK: Overall, corporate tax avoidance schemes are aimed at shifting profits from countries with high taxes to countries with low or no taxes. For example, a corporate group can set up a financial entity in Luxembourg, which then provides loans to other companies of that group around the world. The interest that is then paid on those loans increases profits made in Luxembourg, where preferential deals with the tax authorities (known as advance tax rulings) can allow companies to pay exceedingly low tax rates.  

Can you explain how the tax avoidance schemes work in the case of Rio Tinto, the owner of Mongolia’s largest copper and gold mine Oyu Tolgoi, in the southern Gobi region?

VK: In the case of Oyu Tolgoi (OT), the investors behind the mine have set up a structure like the example given above, using a finance company in Luxembourg to shift profits to this low-tax jurisdiction. In fact, 75 per cent of the finance provided to Oyu Tolgoi has been in the form of loans, much of which has been provided using loans from Luxembourg (link). The interest paid for these loans ultimately lowers the taxable profit in Mongolia. Meanwhile, the government has given OT the right to continue to apply tax benefits enshrined in treaties that were terminated years ago, which significantly lowers Mongolia’s tax revenues from OT.

To clarify, the 2009 Investment Agreement Mongolia signed with Rio Tinto and its fellow investors to develop Oyu Tolgoi includes a so-called fiscal stabilization clause. This clause freezes all applicable tax legislation for OT at the 2009 level. In 2013, the Mongolian Government was advised by the International Monetary Fund to renegotiate four treaties, including those with the Netherlands and Luxembourg.

Several months later, the Mongolian Government cancelled these treaties unilaterally. Because of the fiscal stabilization clause, however, Oyu Tolgoi is still allowed to make use of the treaties’ benefits, which facilitate profit shifting.

The Organisations for Economic Co-operation and Development has recently published a report criticizing such fiscal stabilization clauses and the way they compound tax avoidance risks, and now advises governments to limit their use.

The Mongolian government holds a 34-per cent share in Oyu Tolgoi, doesn’t this help to fight tax avoidance?

VK: Well, on the face of it you would expect that this 34-per cent share would allow the government to receive dividends or profit payments from the mine. However, due to a variety of reasons—including the fact that profits are shifted to Luxembourg using loans—the expectation is that Oyu Tolgoi LLC will not make much profit throughout its lifespan. In fact, one estimate by consultancy firm OpenOil puts total dividend payments the government can expect to receive from its share in Oyu Tolgoi at 200 million US dollars, a pitiful sum for such a multibillion-dollar project.

What can we learn from the Oyu Tolgoi case and what course of action do you recommend to fight tax avoidance in extractive industries in Mongolia as well as internationally? Are there international mechanisms to this end?

VK: Currently, Mongolia is implementing a project by the Organisation for Economic Co-operation and Development to tackle the practice known as base erosion and project shifting (BEPS) and curb tax avoidance. Many of the legislative changes proposed through the BEPS project seem promising, although their effectiveness remains unclear. Furthermore, it remains to be seen whether Mongolia’s implementation of these measures, including the final version of the recently amended tax laws—the General Law on Taxation, the Corporate Income Tax Law and the Value Added Tax Law—will have the desired effect.

In relation to Oyu Tolgoi specifically, the government gave away too much in agreeing to the fiscal stabilization clause. This allowed the investors to continue applying defunct tax benefits and effectively gave up the government’s fiscal sovereignty over OT. How this could happen, and what motivated the government at the time to agree to this, is still unclear. Corruption investigations appear to be ongoing and they may provide some explanation, while it seems that an inequality in technical capacity between the government and OT’s investors will likely have played a major role as well. Only once the public has more insight into why events occurred as they did, can we draw lessons for the future.

What could be the contribution of trade unions and other civil society organizations in fighting tax avoidance by multinational corporations?

VK: Internationally, civil society has played a pivotal role in making sure curbing tax avoidance was put on the political agenda, and in informing the public of its detrimental impact on society. In Mongolia, there appears to have been very little attention paid to tax avoidance so far, even though the country likely loses millions of dollars in tax revenues annually because of it (link).

Mongolian trade unions and non-governmental organizations could be at the forefront of tackling this issue, by uncovering it through research, informing the public of its impact, and using public campaigns to pressure politicians to take action. 

For more information on the work by Friedrich-Ebert-Stiftung in Mongolia contact the country office staff and follow the official Facebook fan page for daily updates.

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