Rio Tinto’s Tax Planning in Mongolia

Just 80 kilometers from the Chinese border, in Khanbogd Soum, South Gobi Province, Mongolia, lies one of the world’s largest gold and copper mines, known as Oyu Tolgoi (which means “Turquoise Hill” in Mongolian). The mine’s proven reserves are estimated at 2.7 million tons of copper, 1.7 million ounces of gold, 1,900 tons of silver, and 210,000 tons of molybdenum. Production began in July 2013, and the mine is expected to operate for over 50 years.

During the era of Genghis Khan, this region’s exposed rocks were already being smelted for copper. The Soviet Union identified the mineral deposits before 1990, and in 2010, the Mongolian government approved an investment agreement with Turquoise Hill Resources, a Canadian-listed company, to form the joint venture Oyu Tolgoi LLC (“OT”). The Mongolian government holds a 34% stake in OT, while Turquoise Hill Resources owns the remaining 66%. Behind Turquoise Hill Resources stands the globally renowned mining giant Rio Tinto.

However, the project has faced numerous challenges. In 2010, the development cost was initially estimated at $4.6 billion, but after the investment agreement was signed, the cost ballooned to $10 billion. This increase frustrated the Mongolian government, as it is responsible for covering its proportional share of the development costs. Due to Mongolia’s lack of funds, Rio Tinto and other financial institutions provided interest-bearing loans to help Mongolia cover its share. As development costs rose, so did interest expenses, ultimately reducing Mongolia’s financial returns.

In November 2019, the Mongolian parliament passed a resolution requiring the government to reassess the investment agreement. This included exploring options such as switching to a production-sharing contract or imposing a special mining tax to replace the current equity and financing arrangements. However, as of the publication of this article, no substantial changes have been made to the arrangement. The project has also been plagued by allegations of corruption and environmental concerns.

Beyond these issues, tax disputes have arisen between Mongolia and Rio Tinto. In 2018, Mongolia’s tax authority demanded OT pay 377.1 billion MNT (Mongolian Tugrik, approximately $132 million. 1 MNT = 0.00035 USD) in back taxes based on a tax audit covering 2013–2015. In 2020, the tax authority issued another demand for 649.4 billion MNT (approximately $227 million) based on a tax audit for 2016–2018. Together, the two audits totaled 359 million USD, making this Mongolia’s first transfer pricing-related tax audit case. OT disputed most of the findings and even appealed the disputes to the London Court of International Arbitration. In response, Mongolia countersued and threatened to terminate the entire investment agreement.

Let’s delve into the details of this tax dispute.

I. Tax Issues Identified in the Two Audits

According to press releases from Mongolia’s tax authority, the following tax issues were identified during the audits:

1. Findings from the 2013–2015 Tax Audit:

• Management Service Fees: OT failed to withhold taxes on 589.4 billion MNT (approximately $206 million) in management service fees paid to Rio Tinto;
• Loan Interest: OT failed to withhold taxes on part of the 522.1 billion MNT (approximately $183 million) in shareholder loan interest paid to Rio Tinto affiliates;
• Export Royalties: OT underpaid 24.3 billion MNT (approximately $9 million ) in export royalties;
• Foreign Exchange Losses: OT overstated its cumulative losses by 402.6 billion MNT (approximately $141 million) due to “unrealistic exchange rate differences.”

2. Findings from the 2016–2018 Tax Audit:

• Management Service Fees: OT failed to withhold taxes on 549 billion MNT (approximately $192 million) in service fees;
• Interest Expenses: OT failed to withhold taxes on 1,953.5 billion MNT (approximately $684 million) in interest payments;
• Export Duties: OT underpaid 46.7 billion MNT (approximately $16 million) in export royalties;
• Foreign Exchange Losses: OT overstated its exchange losses by 395.2 billion MNT (approximately $138 million;)
• Permanent Establishment (“PE”): OT failed to withhold taxes on 134.5 billion MNT (approximately $47 million) for installation, assembly, technical, and IT services provided by foreign entities in Mongolia.

The issues identified in both audits are similar, except that the second audit introduced the matter of PE for foreign service providers in Mongolia. Additionally, the tax authority received external support during the second audit. According to a 18 March 2021 press release by the OECD, the OECD and the Intergovernmental Forum on Mining, Minerals, Metals, and Sustainable Development (“IGF”) assisted Mongolia’s tax authority in strengthening its mining tax audit capabilities. This led to Mongolia’s first transfer pricing-based audit result, recovering $230 million in taxes and reducing cumulative tax losses by $1.5 billion. While the OECD did not explicitly name the audited entity, it is clear that it refers to OT.

Despite the OECD’s support and the perceived “authority” of the audit results, Rio Tinto and OT disputed the findings, publicly asserting their compliance:

“Under Mongolian law, the investment agreement, the underground development plan, and the Mongolian tax authority’s guidance on the stabilized tax environment, OT has paid all taxes due. OT complies with all relevant international standards and guidelines, including the OECD’s transfer pricing guidelines.”

Next, we’ll analyze each dispute in detail.