On the Tax Policy in the Oil Sector
Objective deterioration of oil production conditions requires using more sophisticated taxation instruments. The most effective form of taxation of oil production is the taxation of net profit which can be implemented by introducing a special excess profits tax with progressive tax rate determined by the level of project profitability.
Such tax ensures: automatically bringing the tax burden into compliance with the specific conditions of oil production (differentiating the tax burden depending on the profitability of the field); tax progressivity, fuller resource rent extraction; favorable conditions for investing in oil production, including developing fields with increased production costs.
Introducing the excess profits tax is reasonable for new oil fields, the development of which requires higher capital, operational and transportation costs. At the first stage, to test the new taxation mechanism, it is sound to apply the excess profits tax to a limited set of such fields, primarily to the most cost demanding fields which cannot be developed under the regular tax system.
It is advisable to combine the excess profits tax with the mineral extraction tax, which in such cases should act as a minimum guarantee tax and be levied at a reduced rate, e.g. at an ad valorem rate of 15%. Using the mineral extraction tax will guarantee government revenues starting from the moment oil production begins as well as in situations of low oil prices and high production costs. If the excess profits tax is used, the rate of export duty on oil should be zero.
Compared to the current tax system, the excess profits taxation is much more complicated in terms of tax administration, which creates the risk of a relative decrease in state budget revenues. Using market oil prices for calculating the tax and organizing the effective control over taxpayers’ expenses are necessary conditions for the effectiveness of the excess profits tax.
Using the excess profits tax at the existing fields is more complicated in terms of tax administration. In our opinion, to stimulate deeper development of the existing fields, it is reasonable to use less complicated tax mechanisms. A possible solution here is a more significant – compared to the current tax system – reduction of the mineral extraction tax rate for fields with a high degree of reserve depletion. This will reduce the tax burden in the late stages of field development and stimulate deeper field development and increased oil recovery factor.
Oil products tax rates should be developed considering the pace of the tax system restructuring in the oil sector. Parallel reduction of excise taxes on oil products will allow to neutralize completely or to a large extent the increase in tax-free prices for oil products in the domestic market as a result of decreased export duties.
In general, the following measures of the state tax policy in respect of the oil sector can be recommended:
1. Continuing the structural reform of the tax system: increasing the economic role of the mineral extraction tax, gradually reducing and eliminating export duties on oil and oil products, reducing excise taxes on oil products. This will result in reduced subsidies to the oil refining sector and the EAEU countries, modernized oil refining, improved energy efficiency, and improved tax system.
2. Introducing the excess profits tax for new oil fields, including a progressive mechanism (progressive tax rates) into tax design. This will ensure the progressiveness of taxation, differentiating the tax burden, fuller resource rent extraction, and creating the necessary conditions for investment.
3. Raising the level of tax administration to ensure the effectiveness of the excess profits tax: using market (non-transfer) oil prices (at the first stage – settlement prices), organizing effective control of taxpayer expenses, ensuring the qualification and objectivity of state control.
4. Continuing the policy of differentiating the tax burden for the existing fields: applying reduced mineral extraction tax rates and export duties for fields with increased production costs.
5. Reducing the tax burden for fields with a high degree of reserve depletion: further reduction of the mineral extraction tax rate for such fields will stimulate their deeper development and increased oil recovery factor.
Yuri Bobylev – PhD, Head of the Mineral Sector Economics Department