How poor countries like Mongolia may be losing millions because of corporate tax practices and legal loopholes

Sarah McNeal is an Extractive Industries Policy Assistant at Oxfam America. This was first posted on its The

Oyu Tolgoi
Oyu Tolgoi

Politics of Poverty blog

When oil and mining companies extract resources in developing countries around the world, tracking the so-called “extractive industry” financial transactions can, at times, feel like a trip through Wonderland. Between the convoluted ownership structures and dead-ends created by corporate confidentiality, following the chain of responsibility from the project to the supposed ultimate beneficiaries – citizens – is rarely straightforward. But Dutch non-profit Centre for Research on Multinational Corporations (SOMO) set out to follow the trail down the rabbit hole anyway. They allege in a recent report that the Canadian company behind Mongolia’s Oyu Tolgoi copper mine may have taken advantage of preferential trade agreements to minimize its tax payments to Mongolia and Canada by as much as $700 million. (The report was produced in collaboration with a local group, Oyu Tolgoi Watch.)

As the SOMO analysis illustrates, the information required (e.g. tax payments) or encouraged (e.g. investment agreements) to be disclosed by companies under standards such as the Extractive Industries Transparency Initiative (EITI) – or by tax payment disclosure laws in Canada or the European Union – can help reveal potentially abusive tax practices. Such multi-million dollar losses have real consequences for the citizens who should be benefitting from the revenue generated by resources in their countries.

Following the money in Mongolia

Let’s take a closer look at the Mongolia case. Mongolia, sometimes referred to as “Mine-golia”, is highly dependent on its mineral resource wealth. Mining products and precious metals made up 87 percent of Mongolia’s total exports for an estimated value of $4.2 billion in 2016. At the same time, poverty levels remain persistently high. The National Statistical Office reported that 29.6 percent of the population lived below the national poverty line in 2016.

The Oyu Tolgoi mine is one of the largest operating copper mines in the world – so large, in fact, that the mine is expected to make up 30 percent of Mongolia’s GDP when it reaches peak production. The mine is jointly owned by the Government of Mongolia (34 percent) and the Vancouver-based Turquoise Hill Resources Ltd. (66 percent), which is itself majority-owned by global mining giant Rio Tinto. As SOMO’s Mining Taxes report highlights, the Mongolian government was unable to raise the necessary capital to finance its portion of the project directly. Thus, Turquoise Hill is currently covering the government’s contribution through an intercompany loan, with the government’s payments being deducted from any future dividends. However, Turquoise Hill is not lending the money directly to Oyu Tolgoi LLC – instead, the funds flow through a chain of subsidiaries in Luxembourg and the Netherlands.

oyu tolgoi 2As it turns out, it is easy to set up “shell companies” – companies that meet the legal requirements for substantial presence on paper but otherwise have no real office or staff – in both Luxembourg and the Netherlands. In Turquoise Hill’s case, the Luxembourg subsidiary has one part-time staff and the Netherlands office has zero. SOMO points out that these arrangements allow corporations to take advantage of preferential tax agreements without establishing full-fledged operations in those countries.

For instance, when the Oyu Tolgoi Investment Agreement was signed in 2009, both Luxembourg and the Netherlands were party to double tax agreements (DTAs) with Mongolia that reduced withholding tax payments from the standard 20 percent to 10 percent and 0 percent respectively. After an IMF report in 2012 declared that these particular agreements could be used to facilitate tax avoidance, Mongolia unilaterally terminated the DTAs. However, thanks to the stabilization clause within the 2009 mine Investment Agreement, the original tax rates still applied to Oyu Tolgoi.

The withholding tax rate was further negotiated down from 10 percent to 6.6 percent (applied retroactively) in 2015 following a disagreement between the government and Turquoise Hill over the financing package for the second phase of the mine. SOMO calculates that if Mongolia’s 20 percent withholding tax rate had been in place, the government could have collected an additional $230 million in taxes from 2011 to 2015 on the outgoing loan interest payments to Turquoise Hill, allowing Mongolia to double its spending on education and health care. Instead, in 2017 Mongolia accepted austerity measures as part of a $5.5 billion bailout package from the IMF, including a significant hike in personal income tax rates. Moreover, by holding the interest profits in Luxembourg (with an effective tax rate 2010-2016: 4.19 percent) rather than Canada (average tax rate 2010-2016: 26.6 percent), SOMO estimates that the company also avoided up to $470 million in tax payments to Canada.

In response to these claims, Turquoise Hill argued that both the Canadian and Mongolian governments approved the tax arrangements and that the company was operating in full compliance with the law. Turquoise Hill also pointed out that the presence of a Bilateral Investment Treaty (BIT), not the DTA, between Mongolia and the Netherlands was the driving force behind opening a Dutch subsidiary. BITs are another common tool used by companies to protect their investments. Most treaties contain arbitration clauses that allow companies to sue governments over regulations they perceive as harmful to their business interests, which may include changes in corporate income tax rates.

Making sure taxes work for citizens

Unfortunately such tax practices are the norm, rather than the exception, within the extractive industries. For instance, another Canadian company, Caledonia Mining Corporation, allegedly took advantage of a DTA between the UK and Zimbabwe to reduce its interest and dividend withholding tax payments to almost nothing. And in December a number of oil, gas and mining giants were accused of adopting similar tactics to avoid paying taxes in Australia.

While there has been a lot of progress on improving the disclosure of taxes paid through payment disclosure laws oyu tolkgoi 3and the EITI, it is disappointing to learn that many of the same companies supporting EITI are involved in these practices. The Oyu Tolgoi case suggests that in addition to strengthening global transparency standards, Oxfam and our allies must continue the coordinated effort on a broader tax justice agenda, including closing the legal loopholes that allow these questionable behaviors to persist. The Netherlands has recognized the need to address such abuses and recently proposed minimum substance requirements for companies, including wage expenses of at least EUR €100,000, to prevent shell companies from enjoying tax treaty benefits. This complements the Dutch government’s commitment to insert clauses against treaty shopping into all of its tax treaties. Other governments should, at minimum, follow the Dutch example and take stronger action against tax abuses. Without such commitments and rule changes, there may be many more stories like Oyu Tolgoi in the future.


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6 Responses to “How poor countries like Mongolia may be losing millions because of corporate tax practices and legal loopholes”
  1. Paddy Carter

    Wouldn’t the level of WHT on interest payments affect the interest rate that Turquoise Hill charged the Mongolian government? That’s a real question, not a rhetorical one. But if I was lending money to a government, I suspect the price (interest rate) we negotiate would be affected by whether or not the government is going to recoup 20% of its interest payments as WHT. So perhaps in the absence of a DTA the Mongolian government might have receive more tax but paid more interest.

    Also (and I could be reading this wrong so please do correct me if so) it looks like the WHT on interest payments under the Mongolian DTA with Luxembourg is the same as under the Mongolian DTA with Canada. In which case (at least until you get to the negotiation down to 6.6%) it’s not obvious that “corporate tax practices and legal loopholes” are costing the Mongolians anything, because it looks no worse than the counterfactual of a Canadian company lending money to the Mongolian government directly from Canada.

    • David Mihalyi

      Yes, generally agree. Though it would have gotten the WHT on dividend now and only pay it back in the form of more expensive debt later.

      • David Mihalyi

        Yes, generally agree. Though it would have gotten the WHT on interest now and only pay it back in the form of more expensive debt later.

  2. Yes Paddy, you are right.

    As the article notes the mine is jointly owned by the Government of Mongolia (34 percent) and the Rio Tinto subsidiary Turquoise Hill. But it doesn’t really get to grips with how this deal works. The GoM’s share is a ‘carried interest’ — i.e. they didn’t have to put up any of the capital that was needed to develop the mine. So Turquoise Hill are lending them the capital for their side of the upfront costs and charging them interest.

    As you point out if Turquoise Hill (or any lender) is willing to lend commercially at X% interest, but are then told that part of that interest would actually held back by the borrower as a withholding tax, then they would have raised the interest rate (or grossed up the payment terms to include the tax) so that they were still getting X% — it makes administrative sense (and no difference to the money outcome) to reduce the WHT rather than raise the interest rate and then tax it back. This is the basis of what is happening when the the article says they ” further negotiated down from 10 percent to 6.6 percent”.

    As you note the 10% WHT rate (which is charged on the debt financed part of Turquoise Hill’s investment) would be the same if it came directly from Canada, and not via the Netherlands/ Lux.

    This is (another) one of those reports — like Paladin Energy in Malawi which is about a mine that hasn’t made a profit yet. This doesn’t mean that no tax should be paid — WHT and royalties are paid up front etc… but we shouldn’t get carried away with the idea of massive missing revenues without really digging into the specifics. And this report really doesn’t do that and so its conclusion that $230m of additional tax should already have been paid is really flawed.

    The deal in Mongolia is important and difficult (NRGI wrote a really good account of it and public and civil society scrutiny of it is important. But I think there is something collectively wrong in the civil society debates on tax (as I’ve said before!) in that organisations with international brands and power are able to take so lightly their responsibility to get it right in relation to making headlines out of these critical and difficult deals that matter so much to the poorest countries. I think the questions you are asking should have been asked at the internal peer review stage of the SOMO report, not now once the damage is done (and I’m sorry, I have a half written blog post but I haven’t written it yet).

  3. I have finally got this written up in some more detail here:

    Its a real shame that Oxfam took SOMO’s simplistic analysis at face value and amplified it, rather than checking the assumptions and considering the commercial context — given that Mongolia had 26 tax treaties with a 10% withholding tax rate on interest the idea that 20% should have been viewed as the standard and only legitimate ‘non-abusive’ rate is not credible. Accepting lower standards of analysis and review means giving up on trying to tell a real scandal from a sensational headline.

    Oxfam set up an impact investment fund to make loans for small and medium sized enterprises (including in Mongolia) that was structured as a Société d’investissement à capital variable Specialized Investment Fund (SICAV -SIF) in Luxembourg. Presumably this would have used the Mongolia-Luxembourg tax treaty (which also had a 10% withholding tax rate on interest)? I hope someone can clarify?