Value Added Tax in the Extractive Industries

IMF Working Papers, October 27, 2023

Source details

Research question: With the first-best policy (apply the standard VAT to the extractive industry) infeasible in the medium-term for lower capacity countries, what second-best VAT policy designs should be adopted?
Analytical focus: Systemic analysis of second-best VAT policy designs considering impacts on three key stakeholders: the investor, domestic suppliers, and the tax administration.
Sector characteristics emphasized: capital-intensive, export-intensive nature of the extractive industries and associated large VAT refund needs.

General conclusion: The generally preferred policy is to provide a VAT exemption for imports and either fully tax or exempt domestic supplies, although country characteristics (and, specifically the relative weighting of stakeholders) matter.
Stakeholder trade-offs:
- Investor: Policies affect input VAT recovery and refund timing, which are material given capital intensity.
- Domestic suppliers: Treatment (taxed or exempt) influences competitiveness and integration into domestic value chains.
- Tax administration: Administrative capacity and refund management shape feasible policy choices.
Administrative challenge: Lower capacity countries often struggle to administer VAT in the extractive industries, partly due to large VAT refund needs and associated refund delays.
Transition recommendation: Governments should make efforts to shorten refund delays and transition to a standard VAT over the longer-term.

Short and medium term:
- Provide a VAT exemption for imports.
- For domestic supplies, choose either full taxation or full exemption based on country-specific characteristics and stakeholder weighting.
- Prioritize measures to shorten VAT refund delays to reduce fiscal and investor distortions.
Long term:
- Aim to transition to a standard VAT regime for the extractive industries when administrative capacity permits.