By increasing the economic cut off rate royalties

Info icon This preview shows pages 48–50. Sign up to view the full content.

View Full Document Right Arrow Icon
By increasing the economic cut-off rate, royalties reduce the economic life of a project. 70 68 Some countries link the royalty rate to parameters like average daily production, oil price, water depth, field location, depth of reservoir, and crude oil quality. 69 For a detailed description of royalty practice in various countries, see Otto (1995). 70 The impact of this is to leave in the ground hydrocarbons that would otherwise be produced. Table 9. Ring Fencing How do they work? Ring-fencing is an industry-specific feature. This refers to the delineation of taxable entities. While corporate income tax normally applies at company level, in the petroleum sector the taxable entity is often the contract area or the individual project. When ring fencing applies at contract area or project level, income derived from one area/one project cannot be offset against losses from another area/project. Another type of ring fencing separates upstream from downstream operations. Usually all costs associated with a given block or license must be recovered from revenue generated within that block: the block is ring fenced. However, some countries allow exploration costs to cross the fence. 71 Advantages and Disadvantages to Host Governments The objective of ring fencing is to protect the level of current tax revenue and, to some extent, level the playing field by treating newcomers and existing investors equally. The dis- advantage of ring fencing is that it does not incentivize exploration and investment activi- ties. However, by allowing costs to cross the fence, the host government may end up subsidizing unsuccessful exploration. Some countries allow the consolidation of upstream, transportation and processing activi- ties, and an array of arrangements is used for LNG projects, which involve various degrees of consolidation. Other countries have preferred to maintain the integrity of their tax systems and to provide similar level of incentives through the definition of transfer prices or through other form of incentive. Effect on Investment Decisions The relaxation of ring fencing can provide a strong financial incentive to investors, espe- cially those who have existing production or are in a tax paying position. The existence of a cost recovery limit may enhance the importance of this type of incentive. 71 In New Zealand, a 100 percent deduction is given for exploration expenditure in the year in which it is incurred; development expenditure is allowed as a deduction over 7 years from the date of expenditure for offshore wells, and any losses arising are not ring fenced either to permits, fields, or even the trade. That is, losses can be offset against any New Zealand income of the company or group of companies.
Image of page 48

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Fiscal Systems for Hydrocarbons 39 Table 10. Corporate Income Tax How do they work?
Image of page 49
Image of page 50
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern