Agreements on Double Taxation Run Afoul
May 16 (Mongolian Economy) Mining is the engine to Mongolia's economy. However, the legal environment is acting as a dead weight creating a jam for the development train .
The double taxation agreement, which is the second-most important contract after an Investment agreement, might have less beneficial results for Mongolia than its partners. A double taxation agreement—a tax claim by two or more jurisdictions on the same income—is is the basic protection to a country's national foreign trade and economic security.
Mongolia has agreed to such contracts within 35 countries. At present, 30 of them are officially valid. Twenty-six double taxation agreements were ratified between 1991 and 1998, with about eight more passed from 1997 to 2007, meaning about three-quarters of all double taxation agreements were legalised before 1999.
At the time Mongolia was not at the centre of attention like it is now. The government was more willing to make concessions then, hoping to attract investment to Mongolia. Mongolia promised a secure environment by creating a flexible taxing environment for foreign investors. There was little economic growth in Mongolia back then.
Mongolia had little experience with economic agreements and did not fully understand the consequences a contract could have. Thus, the authorities signed double taxation agreements with almost any country that applied without reviewing the contract clauses or doing much research. It is a common that developed countries benefit more than developing countries from double taxation agreements.
Three Strikes
Mongolia is like a company seeking great profits. Its owners are hoping for big gains with few losses. But what should he do when a competitor comes in and wants to expunge his company from the market, take all the profits with him? This is the fear that Mongolians have. Obviously Mongolians should respond by protecting their income.
Every country and company seeks profits for their products. Who would want to work without making any gains? But what should be done if big transnational companies want to snatch up the market? What if they want to play a game with their weaker partners, looking for a way to pay the least amount of taxes possible using loopholes in domestic laws, regulations and agreements with other countries?
"We have made rather poor agreements compared to those made by the United Nations, as well as double taxation agreements signed by countries similar to or even more underdeveloped countries than Mongolia, like the Philippines and Ghana", said J. Ganbat, the head of Income Division of the Budget Policy Department at the Ministry of Finance.
Issues derived from double taxation agreements are causing headaches for the Ministry of Finance. It cannot collect taxes from some entities existing within Mongolia due to double taxation regulations. The Mongolian Domestic Income Taxing Law for Enterprisers orders that a non-residential individual or entity must set aside 20 percent of earnings for taxes. However, previous double taxation agreements state that one country (India) is responsible for paying just 15 percent tax, while around 10 others need pay only 10 percent tax. There are also four countries that do not have to pay any taxes at all.
This law also orders 20 percent royalty payments be taken from non-residential tax payers. But those that signed double taxation agreements leave only one country (Russia) left to pay that 20 percent, while 10 other countries pay 10 percent. Even more surprising, the double taxation agreement with Switzerland allows it to avoid paying taxes completely. Mongolia has given too much freedom to its foreign investors.
The amendments made to the Mongolian Domestic Income Taxing Law for Enterprisers, passed on 26 November 2011, has non-residential tax payers responsible for paying 20 percent tax on their Mongolian income. The double taxation agreements signed with Canada, North Korea, India, Italy, Luxembourg, Malaysia and the Netherlands give the Mongolian governments the right to take taxes for money incurred from technical service payments. However, Mongolia can't collect from any other country.
Non-residential tax payers have to pay 20 percent taxes on their income from interest . However, Belgium, France, Luxembourg, the Netherlands and Switzerland are exempt from taxes from interest derived from any banking or financial organization in Mongolia. In addition, countries such as Kuwait and United Arabian Emirates do not pay any kind of tax on interest. The double taxation agreement itself contains lots of fouls and a claim could be filed to World Trade Organisation (WTO).
A recent example is the case of South-Gobi Sands. Changes in laws are being made so Mongolia can have the power to regulate mine transfer and taxing issues. However, Article 13 in the double taxation agreement with Canada, prohibits Mongolia will from collecting any taxes. The article says that Mongolia can take taxes from shared profits both directly and indirectly related to real estate located in Mongolia. It is only enforced, however, on rented estates used for "real estate" purposes. For that reason, Mongolia cannot benefit from taxes from these kinds of assets. Thus, changes to the double taxation agreement with Canada must be made.
Foul
Taking advantage of weakness in the double taxation agreement, foreign companies register their head office in the Netherlands or Luxembourg to avoid taxes. There are statistics revealing that 27 percent of direct investments made from 1999 to 2010 to Mongolia were from companies registered in the Netherlands.
The Mongolian National Foreign Investment Authority states that the Netherlands allowed investments worth USD 232.9 million in 2010. According to Mongolian Natural Resource Authority, 23,502 exploration and exploitation licences have been granted. Of those special licences, 26 percent (6,125) are owned by foreign enterprises. Among these foreign invested companies, the Netherlands possesses 80 licences, while Luxembourg holds four. Mongolia is losing huge sums of tax income to foreign countries.
It would require too much time and effort to correct all these agreements. The Ministry of Finance has sent several petitions requesting changes to Luxembourg and the Netherlands since last year. However, neither replied until the ministry sent a message stating that if they refused to accept the petition Mongolia would cancel the agreement. Shortly afterwards Mongolia's foreign counterparts agreed to negotiate. Even though Mongolia has been trying to make changes and improve the terms of the double taxation agreement, there is still the risk that companies could hold their head offices abroad to avoid paying taxes.
"Even if we could revise and renew the tax laws and regulations, there are still too many flaws in the double taxation agreement", said budget policy head at the Ministry of Finance B. Batjargal. "And these are the main issues to tackle with that create tax exemptions. Non-residential tax payers have to pay a 20 percent tax on dividends, royalties, services and interest. But we are in a position that we can't collect from most of them".
The Ministry of Finance has developed a draft law that would replace the current double taxation law. According to the ministry, all double taxation agreements could be annulled. After some revisions to the domestic tax law, agreements applicable to the reformed double taxation law could be conducted with foreign countries in a diplomatic way.
Batjargal explained if the gap within the law is not filled soon, then Mongolia won't be able to collect on some taxes once the mining industry gains momentum.
The Ministry of Finance and the General Department of Taxation have collaborated on a revision of the Mongolian Domestic Income Taxing Law. It grants that if more than 10 percent of shares of a company with exploration licences is sold, Mongolia could tax the profits from the transaction.
The essence of the double taxation law lies in the fact that the associate must pay tax to the government from where an income comes from. If a Chinese company is making money on Mongolian territory, it has to pay taxes. It is crucial to fix the problem now, when mining is booming and transnational companies are operating in Mongolia.
The Getaway
When introducing the 2012 budget to Parliament in October last year, Prime Minister S. Batbold said that if the double taxation law was found to be detrimental to national security then it must be revised and changed.
Depending on the effect it has on the nation, annulments can be made. Parliament may cancel double taxation agreements beginning at the second quarter of this year. All double taxation agreements are planned for cancellation by 2013. Those affected will be notified before 30 June.
There are examples from abroad of annulling such agreements when impacting on revenue earned. For example, on 30 June 2008 Argentina annulled its double taxation agreement with Austria because the former was not receiving any tax revenue. Both countries' investors were displeased with the decision. On 29 June 1987, America also cancelled its agreement with the Netherlands. The end agreement was a great win for America because a third party could not abuse the agreement.
Although nations have been negotiating for resolutions to problems with amendments to laws for about eight years, Dutch authorities have refused to change their country's status as a paradise for tax collection.
The double taxation agreement, which is the second-most important contract after an Investment agreement, might have less beneficial results for Mongolia than its partners. A double taxation agreement—a tax claim by two or more jurisdictions on the same income—is is the basic protection to a country's national foreign trade and economic security.
Mongolia has agreed to such contracts within 35 countries. At present, 30 of them are officially valid. Twenty-six double taxation agreements were ratified between 1991 and 1998, with about eight more passed from 1997 to 2007, meaning about three-quarters of all double taxation agreements were legalised before 1999.
At the time Mongolia was not at the centre of attention like it is now. The government was more willing to make concessions then, hoping to attract investment to Mongolia. Mongolia promised a secure environment by creating a flexible taxing environment for foreign investors. There was little economic growth in Mongolia back then.
Mongolia had little experience with economic agreements and did not fully understand the consequences a contract could have. Thus, the authorities signed double taxation agreements with almost any country that applied without reviewing the contract clauses or doing much research. It is a common that developed countries benefit more than developing countries from double taxation agreements.
Three Strikes
Mongolia is like a company seeking great profits. Its owners are hoping for big gains with few losses. But what should he do when a competitor comes in and wants to expunge his company from the market, take all the profits with him? This is the fear that Mongolians have. Obviously Mongolians should respond by protecting their income.
Every country and company seeks profits for their products. Who would want to work without making any gains? But what should be done if big transnational companies want to snatch up the market? What if they want to play a game with their weaker partners, looking for a way to pay the least amount of taxes possible using loopholes in domestic laws, regulations and agreements with other countries?
"We have made rather poor agreements compared to those made by the United Nations, as well as double taxation agreements signed by countries similar to or even more underdeveloped countries than Mongolia, like the Philippines and Ghana", said J. Ganbat, the head of Income Division of the Budget Policy Department at the Ministry of Finance.
Issues derived from double taxation agreements are causing headaches for the Ministry of Finance. It cannot collect taxes from some entities existing within Mongolia due to double taxation regulations. The Mongolian Domestic Income Taxing Law for Enterprisers orders that a non-residential individual or entity must set aside 20 percent of earnings for taxes. However, previous double taxation agreements state that one country (India) is responsible for paying just 15 percent tax, while around 10 others need pay only 10 percent tax. There are also four countries that do not have to pay any taxes at all.
This law also orders 20 percent royalty payments be taken from non-residential tax payers. But those that signed double taxation agreements leave only one country (Russia) left to pay that 20 percent, while 10 other countries pay 10 percent. Even more surprising, the double taxation agreement with Switzerland allows it to avoid paying taxes completely. Mongolia has given too much freedom to its foreign investors.
The amendments made to the Mongolian Domestic Income Taxing Law for Enterprisers, passed on 26 November 2011, has non-residential tax payers responsible for paying 20 percent tax on their Mongolian income. The double taxation agreements signed with Canada, North Korea, India, Italy, Luxembourg, Malaysia and the Netherlands give the Mongolian governments the right to take taxes for money incurred from technical service payments. However, Mongolia can't collect from any other country.
Non-residential tax payers have to pay 20 percent taxes on their income from interest . However, Belgium, France, Luxembourg, the Netherlands and Switzerland are exempt from taxes from interest derived from any banking or financial organization in Mongolia. In addition, countries such as Kuwait and United Arabian Emirates do not pay any kind of tax on interest. The double taxation agreement itself contains lots of fouls and a claim could be filed to World Trade Organisation (WTO).
A recent example is the case of South-Gobi Sands. Changes in laws are being made so Mongolia can have the power to regulate mine transfer and taxing issues. However, Article 13 in the double taxation agreement with Canada, prohibits Mongolia will from collecting any taxes. The article says that Mongolia can take taxes from shared profits both directly and indirectly related to real estate located in Mongolia. It is only enforced, however, on rented estates used for "real estate" purposes. For that reason, Mongolia cannot benefit from taxes from these kinds of assets. Thus, changes to the double taxation agreement with Canada must be made.
Foul
Taking advantage of weakness in the double taxation agreement, foreign companies register their head office in the Netherlands or Luxembourg to avoid taxes. There are statistics revealing that 27 percent of direct investments made from 1999 to 2010 to Mongolia were from companies registered in the Netherlands.
The Mongolian National Foreign Investment Authority states that the Netherlands allowed investments worth USD 232.9 million in 2010. According to Mongolian Natural Resource Authority, 23,502 exploration and exploitation licences have been granted. Of those special licences, 26 percent (6,125) are owned by foreign enterprises. Among these foreign invested companies, the Netherlands possesses 80 licences, while Luxembourg holds four. Mongolia is losing huge sums of tax income to foreign countries.
It would require too much time and effort to correct all these agreements. The Ministry of Finance has sent several petitions requesting changes to Luxembourg and the Netherlands since last year. However, neither replied until the ministry sent a message stating that if they refused to accept the petition Mongolia would cancel the agreement. Shortly afterwards Mongolia's foreign counterparts agreed to negotiate. Even though Mongolia has been trying to make changes and improve the terms of the double taxation agreement, there is still the risk that companies could hold their head offices abroad to avoid paying taxes.
"Even if we could revise and renew the tax laws and regulations, there are still too many flaws in the double taxation agreement", said budget policy head at the Ministry of Finance B. Batjargal. "And these are the main issues to tackle with that create tax exemptions. Non-residential tax payers have to pay a 20 percent tax on dividends, royalties, services and interest. But we are in a position that we can't collect from most of them".
The Ministry of Finance has developed a draft law that would replace the current double taxation law. According to the ministry, all double taxation agreements could be annulled. After some revisions to the domestic tax law, agreements applicable to the reformed double taxation law could be conducted with foreign countries in a diplomatic way.
Batjargal explained if the gap within the law is not filled soon, then Mongolia won't be able to collect on some taxes once the mining industry gains momentum.
The Ministry of Finance and the General Department of Taxation have collaborated on a revision of the Mongolian Domestic Income Taxing Law. It grants that if more than 10 percent of shares of a company with exploration licences is sold, Mongolia could tax the profits from the transaction.
The essence of the double taxation law lies in the fact that the associate must pay tax to the government from where an income comes from. If a Chinese company is making money on Mongolian territory, it has to pay taxes. It is crucial to fix the problem now, when mining is booming and transnational companies are operating in Mongolia.
The Getaway
When introducing the 2012 budget to Parliament in October last year, Prime Minister S. Batbold said that if the double taxation law was found to be detrimental to national security then it must be revised and changed.
Depending on the effect it has on the nation, annulments can be made. Parliament may cancel double taxation agreements beginning at the second quarter of this year. All double taxation agreements are planned for cancellation by 2013. Those affected will be notified before 30 June.
There are examples from abroad of annulling such agreements when impacting on revenue earned. For example, on 30 June 2008 Argentina annulled its double taxation agreement with Austria because the former was not receiving any tax revenue. Both countries' investors were displeased with the decision. On 29 June 1987, America also cancelled its agreement with the Netherlands. The end agreement was a great win for America because a third party could not abuse the agreement.
Although nations have been negotiating for resolutions to problems with amendments to laws for about eight years, Dutch authorities have refused to change their country's status as a paradise for tax collection.
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