An overview of PNG's tax framework and incentive structures

The 2018 national budget is the country’s first in the new Medium-Term Revenue Strategy (MTRS) that runs from 2018 through to 2022. Budget and tax changes are created to align with the MTRS, which in turn is guided by the government’s 100-day plan and the Alotau Accord II that was signed in August 2017 by Prime Minister Peter O’Neill and eight coalition partners.

2018 Natioal Budget

When presenting Papua New Guinea’s 2018 budget in November 2017, Charles Abel, deputy prime minister and minister of the treasury, highlighted five major measures that were to be implemented from January 1, 2018 onwards. These are centred on:

• Improving revenue collection through greater compliance and the strengthening of revenue agencies;

• Removing the training levy and double deduction for training expenditure;

• Increasing import tariffs and excise tax on diesel fuel;

• Changing the export duty applicable to unprocessed, old-growth logs; and

• Introducing a new Tax Administration Bill. In addition to these measures, there are a number of minor technical amendments, as well as amendments to address the unintended consequences of changes enacted in 2017 to dividend withholding tax and additional profits tax on resource projects.

MTRS

A core element of the MTRS is to continue to build up a revenue base that is able to finance the government’s expenditure plans on a sustained basis, while also ensuring that these revenues are generated in an efficient and fair manner.

The formation of the MTRS was aided by the findings of the PNG Taxation Review in late 2015 and an August 2017 report by an IMF technical team on the country’s tax administration, tax policy and legislation. The MTRS provides a detailed framework for improving the effectiveness and efficiency of PNG’s tax system, and its contents are therefore highly relevant in understanding the scope and direction of future budget changes.

According to the MTRS, the government will focus on the following matters in the next five years:

• Continue with increased compliance activities, particularly with respect to large taxpayers;

• Broaden the revenue base by introducing further measures to fill tax gaps and rationalise tax incentives;

• Continue the removal of tax concessions, tax exemptions and special arrangements;

• Continue to rebalance the tax composition from income to broader-based taxes, including a review of goods and services tax (GST) rates offset by reducing the tax wedge on labour income;

• Introduce a capital gains tax to broaden the tax base, reduce opportunities for evasion and enhance equity;

• Review the rationalisation of tax incentives and the potential for lower corporate income tax rates;

• Bring small and medium-sized enterprises into the tax net through a simplified tax regime;

• Provide more tax certainty by simplifying and modernising the tax legislation; and

• Strengthen tax expenditure reporting.

Tax Regime

PNG’s tax regime is based on the Income Tax Act, the GST Act, the Stamp Duties Act, the Customs Act and the Excise Tax Act, and is supported by related legislation and regulations. Within the Income Tax Act, a specific set of rules applies to taxpayers operating in the natural resources sector – namely the mining, gas and petroleum segments – while the general provisions of the other laws apply to all other taxpayers, as well as to those taxpayers engaged in mining, petroleum or gas operations.

Types of Corporate Entity

A number of different types of legal entities are available to those looking to do business in PNG. These include incorporating a PNG company (subsidiary), registering as an overseas company in PNG (a PNG branch), entering into a partnership agreement and establishing a trust. The choice of entity is generally based on the commercial goals of the enterprise, legal and regulatory requirements, and the consequences for taxation. Most foreign enterprises operating in PNG do so through a subsidiary or a branch.

Companies Act Regulations

Where a company incorporated outside PNG begins to carry on business in the country, it is required upon commencement to register as an overseas company under the Companies Act. For the purposes of the Companies Act, the term “carrying on business” is given an extended meaning, but otherwise it has an ordinary meaning. As a general rule, an overseas company that enters into a contract for work to be done in PNG and undertakes work in PNG for a period of more than 30 days would be regarded as carrying on business in the country under the framework of the Companies Act.

Investment Promotion Act

Both domestic and foreign companies with foreign shareholdings of 50% or more – meaning held or controlled by non-PNG citizens or effectively controlled by non-PNG citizens – are required to be certified by the Investment Promotion Authority before they can carry on business in PNG.

The meaning of carrying on business under the Investment Promotion Act, so far as is relevant, is identical to the meaning under the Companies Act. It follows that this requirement applies whether an overseas company intends to carry on business in PNG through a subsidiary or a branch.

Residence Rules for Corporate Tax

A company is deemed a resident for corporate income tax (CIT) purposes if it meets either the incorporation test or the management and control test.

Under the incorporation test, a company incorporated in PNG is automatically regarded as a PNG tax resident. However, the law of another country and a relevant double taxation agreement (DTA) may result in a company also being treated as resident of another country.

Under the management and control test, a company is a PNG tax resident if it carries on business in the country, and is managed and controlled in PNG, regardless of where it is incorporated. Generally, a company is managed and controlled in PNG if key decisions affecting the company are made at directors’ meetings held in PNG. This applies to companies incorporated outside PNG that trade in the country and have its voting power controlled by resident shareholders.

Permanent Establishments

The concept of a permanent establishment (PE) has limited significance in PNG’s domestic taxation law, and is defined to mean a place at or through which a person carries on any business. Under local law, PNG will seek to tax the income of a non-resident that is sourced in PNG, whether or not that income is derived at or through a PE in PNG. Where PNG has entered into a DTA, the concept of a PE as defined in the DTA becomes more important, as it will then be one of the factors determining PNG’s taxation rights over income sourced in PNG, particularly with respect to the business profits of a non-resident company. In general terms, PNG’s DTAs:

• Define a PE as a fixed place at or through which the business of an enterprise is wholly or partly carried out; and

• Deem a PE to exist in various circumstances, including those relating to the presence of substantial equipment in PNG and the time spent by personnel of an enterprise furnishing services in PNG.

Corporate Taxation

Companies that are deemed residents of PNG are liable for income tax on their worldwide income. Companies that are not residents of PNG are only required to pay local tax on income that is sourced in PNG. A non-resident’s PNG-sourced passive income, including dividends, interest and royalties, is generally only subject to withholding tax. In most cases, the payer of the dividend, interest or royalty must withhold the relevant amount of the tax and remit this to the Internal Revenue Commission (IRC).

Resident companies’ trading profits and other income – except income that is specifically exempt – are assessed tax at a rate of 30%, whereas non-resident companies that carry on operations in PNG are assessed tax at a rate of 48%. Taxable income: Taxable income is defined as assessable income minus allowable deductions. In practice, profits are calculated for tax purposes by reference to the profits reported in the financial accounts. Accounts must be prepared in accordance with PNG accounting principles, which follow International Financial Reporting Standards. Dividend income: Dividends are included in the assessable income of a resident company shareholder, unless otherwise exempt from CIT.

Inter-company dividends are dividends received by a resident company from other companies, whether resident or non-resident. While being assessable to tax, inter-company dividends are generally subject to a full tax rebate and are effectively received tax-free. However, where a company has losses on other activities or losses carried over from earlier years, those losses are applied against dividend income before the calculation of the dividend rebate. From January 1, 2017 no dividend withholding tax applies to dividends paid by a PNG resident company to another resident company.

In most cases, the payment of a dividend by issuing shares, known as stock dividends, is subject to the same taxation treatment as the payment of a cash dividend or through the distribution of other property. However, dividends paid by the issue of shares wholly and exclusively out of profits arising from the sale or revaluation of assets not acquired for the purpose of resale at a profit are exempt from income tax and dividend withholding tax. Interest income: Unless exempt under specific provisions, any interest paid or credited by a financial institution, the central bank or a company to a person who is resident in PNG is included in income, and the institution or person paying the interest is liable to withhold and pay tax upon the amount. Exchange gains: Generally, foreign exchange gains realised and derived from debts made on or after November 11, 1986 and denominated in a currency other than the kina are included in assessable income. Realised foreign exchange gains on revenue items are also included in assessable income. Foreign income: PNG resident companies are liable for CIT on their income from all sources, including income that is derived from foreign sources. However, a foreign tax credit may be available to offset foreign tax paid against the tax payable in PNG.

There are no provisions that permit deferral of the taxation of income derived outside PNG. Subject to the operation of a DTA, foreign-sourced income derived by a resident of PNG is subject to tax in PNG in the year in which it is derived, whether or not that income is repatriated to PNG. Deductions: General deduction provisions provide that all losses and expenditures – to the extent they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing that income – are allowable deductions.

However, the general deduction provisions do not allow a deduction if a loss or expenditure is an outflow of capital or of a capital, private or domestic nature, or is incurred in relation to the gaining or production of tax-exempt income. Exchange losses: Generally, foreign exchange losses realised and derived from debts made on or after November 11, 1986 and denominated in a currency other than the kina are an allowable deduction. Realised foreign exchange losses on revenue items are also allowable deductions.

Interest Expenses

A deduction is typically available for interest incurred on an arm’s-length basis, subject to meeting the general principles and conditions for deductibility. Where interest is incurred in connection with the construction or acquisition of a plant item or capital asset, the interest is not immediately deductible. Rather, such interest is deemed to form part of the cost of the asset. In the case of plant, this interest will form part of the base from which future depreciation deductions are claimed.

Thin Capitalisation

Thin capitalisation rules apply to PNG companies across all industries with a permitted debt-to-equity ratio of 3:1 for taxpayers in the natural resource sector (mining, oil and gas), and 2:1 for all other taxpayers. Thin capitalisation rules do not apply to licensed financial institutions. If the permitted ratio is breached, a proportion of interest paid will be denied as a tax deduction.

Capital Gains

There is no general capital gains tax in PNG. However, profits arising from the sale of property acquired for the purpose of resale at a profit, or from carrying out a profit-making scheme, are taxable as ordinary income.

Net Operating Losses

Domestic trading losses may be offset against all income received in the same accounting period or carried forward and offset against future trading profits. The limitation period on carrying forward losses is typically 20 years. Losses may not be carried back against prior years’ profits. Primary production losses and resource project losses may be carried forward without a time limitation, but again, they may not be carried back. The deduction of losses in all cases is subject to a 50% or more continuity of shareholding and control test, or a continuity of business test where there is a breach of the ownership test.

Foreign losses incurred by a resident taxpayer from a source outside PNG, other than in relation to export market development, are not deductible against assessable income derived within PNG. In practice, overseas losses can be carried forward and offset against overseas income for up to 20 years.

Payments to Foreign Affiliates (Management Fees)

The deduction available to a taxpayer for management fees paid to an associated person is limited to the greater of:

• 2% of the assessable income derived from PNG sources by the taxpayer; or

• 2% of the total allowable deductions, excluding management fees, incurred by the taxpayer in PNG. The limitation is applicable to both resident and non-resident taxpayers. Special rules apply to mining, petroleum and gas companies. These limits may not apply where the recipient of the management fee is resident in a country with which PNG has a DTA, or where it can be demonstrated that the management fee arrangements do not have the purposes or effect of avoiding or altering the income tax payable in PNG.

Withholding Taxes

As with most jurisdictions around the world, withholding taxes comprise an important part of tax revenue for the government. Below are details of PNG’s major withholding tax categories. Dividend (withholding) tax: From January 1, 2017 dividends paid by a PNG company are generally subject to a 15% dividend withholding tax. Dividends paid to PNG resident companies and superannuation funds, as well as non-resident superannuation funds, may be exempt from withholding tax. Interest (withholding) tax: Where interest is paid or credited by any person to a non-resident or to a resident, a 15% withholding tax must be deducted. The withholding tax acts as a final tax for non-residents, and the rate may be reduced where the recipient is a resident of a country with which PNG has a DTA. Royalty (withholding) tax: Tax is imposed on royalties and similar payments made to non-residents who do not have a PE in PNG. The tax must be withheld by the payer on behalf of the payee and remitted to the IRC. The tax payable on royalties to a party who is not an associated person is the lesser of:

• 48% of the net royalty, calculated as gross royalty less applicable expenses; or

• 10% of the gross royalty. Royalty payments to a non-resident associated person are liable to a withholding tax of 30% of gross payments (subject to any DTA), with no option to adopt the net income basis.

The definition of an associated person is detailed and widely drawn. Broadly speaking, it encompasses relatives, partners, companies under effective common control and related trust interests. There is also a 5% withholding tax on mining, petroleum, timber and fishing royalties to landowners. Management fee (withholding) tax: A 17% withholding tax applies to management fees and technical fees paid to non-residents. The withholding tax only applies to the amount allowable as a tax deduction. The tax must be remitted to the IRC within 21 days after the end of the month in which such fees are paid or credited. Foreign contractor withholding tax: There are specific provisions in the Income Tax Act that deal with the taxation of non-residents, other than individuals, who conduct certain contract activities in PNG. Such non-residents are referred to as foreign contractors.

Contract activities include undertaking installation and construction projects or providing professional and consultancy services in PNG, as well as engaging in equipment lease and charter payments. Income derived from these contacts is subject to a 15% foreign contractor withholding tax.

The PNG contracting entity must provide the IRC with a copy of a relevant contract within 14 days of its signing, following which the foreign contractor withholding tax can be deducted from payment to the foreign contractor. Where tax is withheld from a foreign contractor, the deductions are to be remitted to the IRC within 21 days after the end of the month in which the payment was made.

From January 1, 2017 foreign contractors no longer have the option under local law to file an income tax return with the government and pay tax on net profit instead of paying withholding tax.

Non-Resident Insurers Tax

Premiums paid to non-resident insurers in respect to insurance contracts on property situated in PNG or related to insured events that can only occur in PNG are subject to tax. The tax is calculated on an amount equal to 10% of the gross premium, which is taxed at the non-resident tax rates of 48% for companies and 30% for unincorporated associations. Tax treaties may limit the rate of tax applied.

Overseas Shippers Tax

Income derived by overseas shippers or charterers carrying passengers, livestock, mail or goods out of PNG is liable to taxation in PNG. The tax is calculated on an amount equal to 5% of gross income, which is taxable at the non-resident rate of 48% in the case of companies.

The IRC may exempt the overseas shipper from such tax if the shipper’s home country exempts PNG shippers from a similar tax.

Double Taxation

PNG has concluded DTAs with Australia, Canada, China, Fiji, Germany, Indonesia, Korea, Malaysia, New Zealand, Singapore and the UK. However, as of December 2017, Germany had not yet ratified the treaty. Furthermore, PNG has negotiated but not yet ratified a DTA with Thailand.

Tax rates imposed on payments to non-residents and the liability of non-residents to PNG tax may be affected by a DTA, and these rates are summarised in the chart to the left. PNG domestic legislation provides an exemption from withholding tax for interest and dividends in certain circumstances. The higher rates quoted are the maximum rates allowable under the DTA, however, the domestic exemption may still apply in some circumstances.

Transfer Pricing

Where transactions involving non-residents are deemed not to be at arm’s length, the IRC may impose an arm’s length consideration for income tax purposes and determine the source of any income arising from such transactions.

Corporate taxpayers, including companies, superannuation funds, associates and unit trusts, that have transactions or dealings with international related parties exceeding PGK100,000 ($31,200) in an income year, or have aggregated loan balances with the international related parties in excess of PGK2m ($624,000) at any time during an income year, are required to prepare and lodge an international dealings schedule with their income tax return for that year of income. The schedule requires disclosures be made regarding the nature of the transactions with international related parties, the underlying methodologies followed to determine transfer prices, and the nature of documentation supporting those pricing methodologies.

Business Income Withholding Tax

Payers who make an eligible payment of PGK5000 ($1560) or more for one contract are required to register with the IRC as a paying authority and attend to the obligations imposed on it under the law. Eligible payments include outlays for services such as construction, road transportation, motor vehicle repairs, joinery services and security services.

Where a business income payee enters into a contract with a paying authority to perform work or becomes entitled to receive a business income payment but does not produce a certificate of compliance, a 10% business income withholding tax is required to be deducted by the paying authority based on the gross payment. Furthermore, the withholding tax deducted must be remitted to the IRC within 14 days after the end of the month in which the tax was deducted.

Tax Credits & Incentives

A summary of the most popular credits and incentives for companies are outlined below: Foreign tax credit: A foreign tax credit may be available to offset foreign tax paid against PNG tax payable. The foreign tax credit is limited to either the foreign tax paid or the average PNG tax payable on the foreign income, whichever is less. There is no mechanism to carry forward excess foreign tax credits for utilisation in a subsequent year. Double deduction for training costs: Certain staff training costs, including the cost of full-time training officers and tourism training, are eligible for a double deduction until December 2017. The double deduction has been abolished from January 1, 2018. Export development deduction: Expenditures incurred in the country for sales promotion outside PNG of goods manufactured in the country, or incurred in the promotion of tourism, are eligible for double deduction. The total tax saving cannot exceed 75% of the expenditure incurred. Infrastructure development credit: A tax credit is available to companies engaged in agricultural, mining, petroleum, gas and certain tourism activities that incur expenditure on a prescribed infrastructure development.

In the case of taxpayers that are engaged in mining, petroleum and gas operations, the tax credit is limited to a total of 0.75% of the assessable income or the amount of tax payable for the year (in respect to the mining, petroleum or natural gas project), whichever is less. Excess expenditure over the 0.75% of tax payable may be included in the following year’s tax credit claim.

In the case of taxpayers engaged in agricultural production, the credit is limited to 1.5% of the assessable income or the amount of tax payable for the year, whichever is less.

A prescribed infrastructure development includes a school, aid post, hospital, road and other capital assets that have been approved by the Department of National Planning and the IRC. It cannot be an expenditure required under the Mining Act or the Oil and Gas Act.

A 1.25% tax credit scheme also exists for expenditure incurred in connection with the emergency repair of the Highlands Highway. Agricultural production extension services: A 150% deduction is available for expenditure on services provided free of charge to smallholder growers, including the provision of advice, training and technical assistance in relation to primary production, and delivered for the purpose of assisting growers with production, processing, packaging and marketing activities.

Other Tax Incentives

Other tax incentives available in PNG include:

• 100% deduction for most capital expenditure on primary production;

• 100% deduction for capital expenditure on assets used directly in the manufacturing process;

• Exemption of income derived from the export of certain manufactured goods;

• Immediate deduction for the costs of acquiring and installing solar heating plants;

• A 10-year tax exemption for qualifying new businesses that locate in prescribed remote areas of the country; and

• A specific deduction for environmental protection and clean-up costs.

Taxation of Other Entities

The taxation scheme for entities and vehicles other than standalone corporations are as follows: Partnerships: A partnership is defined to include any association of persons in joint receipt of income. The members of a partnership include their individual share of the profit or loss of the partnership in their own tax returns. The partnership itself is not subject to tax, although it is required to file a tax return. Joint ventures: Unincorporated joint ventures are permitted to carry on mining and petroleum operations, and the respective joint venture partners are assessed on their individual share of income on a project basis.

Joint venture operators of a resource project are required to submit a consolidated financial statement for the joint venture as a whole within two months after the end of the year of income. This consolidated financial statement must enumerate details of all expenditure incurred throughout the year by all parties. Furthermore, each joint venture partner will be required to reconcile their tax return to the consolidated financial statement. The joint venture itself is not subject to tax and is not required to file an income tax return. Trusts: A trustee of a resident trust estate is taxed on the net income of the trust estate at the rate of 30%. The beneficiaries of a trust estate are also subject to income tax on their entitlement to the net income and on actual distribution. Landowner resources trusts: Where interests in natural resource projects are held in trust for landowners, a trust may be approved by the Minister of Finance to be a Landowner Resources Trust. Net income derived from such a trust is taxed at the rate of 30% and the tax is payable by the trustee. Distributions of income and capital from a Landowner Resources Trust to its beneficiaries are exempt from income tax in the hands of the beneficiaries. Superannuation funds: A superannuation fund is resident if it is established or managed in PNG. The taxable income of a resident superannuation fund is subject to tax at the rate of 25%. Dividends paid to a superannuation fund qualify for the dividend rebate. Where an employer’s contributions to a superannuation fund exceed 15% of an employee’s fully taxed salary or wages, the excess contribution is included as assessable income of the superannuation fund.

Individual Taxation

PNG taxation also applies to individuals. However, the scope and tax rates that apply are dependent on the resident status of the individual and the source from which their income is derived. For individuals who are residents of PNG, taxation applies to their worldwide income at marginal tax rates. For non-residents, only income that is sourced in PNG is subject to local tax, and at different rates than what is applied to residents. In broad terms, an individual will be treated as a resident of PNG in a given year of income if he or she spends, continuously or intermittently, more than six months in the country during that year. The tax rates for resident and non-resident individuals are outlined in the table below. Assessable income: Each resident individual is assessed separately; there is no joint assessment for spouses. Taxpayers who only have employment income and are fully taxed at source by virtue of salary or wages tax do not need to complete an annual income tax return. Taxpayers with other income such as interest, dividends, rental income, trust distributions or partnership income must disclose this in an annual income tax return. Benefits to employees: Certain benefits provided to employees are taxed in the hands of the employees at prescribed values. These benefits include accommodation, housing allowances, motor vehicles, education expenses, leave fares, meals, telephones, cash allowances and contributions by an employer to an approved local or overseas superannuation fund. Other fringe benefits such as the provision of entertainment, club subscriptions, domestic electricity and domestic services are not deductible to the employer for income tax purposes.

Additional Taxes

Other taxes that supplement government income include:

GST: In general, GST is imposed at the rate of 10% on the supply of most goods and services in PNG. The GST Act, which came into force in 2003, defines the term “supply” as including all forms of supply, such as the sale, transfer, hire or lease of goods, as well as the provision of services. A supply for GST purposes falls into one of the following three categories:

• Taxable supply, which attracts GST at the rate of 10%;

• Zero-rated supply, which attracts GST at the rate of 0%; or

• Exempt supply, which is not subject to GST. Where a taxable or zero-rated supply is made, a registered person is entitled to a credit for the input tax paid on goods or services used in making the supply. Where an exempt supply is made, GST is not charged in respect of that supply. However, no entitlement exists to allow a recovery of any input tax that is paid on goods or services used in generating the supply.

Businesses having an annual turnover of PGK250,000 ($78,000) or more are required to register for GST, while businesses with annual income of less than PGK250,000 ($78,000) can register voluntarily. Persons or companies that are not registered are not permitted to charge GST.

Training levy: Until 2017 all businesses whose annual payroll exceeded PGK200,000 ($62,400) were subject to a 2% training levy, which was calculated on the sum of the taxable salary/wages, including benefits, of all personnel. The levy was assessed on an annual basis. The amount of the levy payable was reduced by the amount of qualifying training expenses incurred in the training of citizen employees. The training levy has been abolished from January 1, 2018.

Customs duties: Customs duties are imposed on the cost, insurance and freight value of imports at varying rates. With the introduction of GST, the majority of manufacturing inputs attract no duty. Duty is now primarily imposed on items that are produced locally in PNG. Duty can be deferred where goods are to be imported and re-exported within 12 months (or another qualifying period as approved by the Collector of Customs), subject to the approval of the Collector of Customs. A bond must be provided.

Excise duties: Excise tax, at varying rates, is imposed on certain locally manufactured and imported goods – primarily alcohol, tobacco and fuel products – as well as on goods deemed to be luxury items. Stamp duties: Stamp duty applies at varying rates to documents and certain transactions. Of particular note is duty charged on the conveyance of real property, which rises to a maximum of 5% where the value of the real property being transferred exceeds PGK100,000 ($31,200). The duty is payable by the purchaser, and a 5% duty on the unencumbered value of land may also be payable where there is a transfer of shares in certain landholding companies.

Other taxed transactions include share transfers (including some share buy-backs), subject to a rate of 1%. Leases of goods are also subject to stamp duty at a rate of up to 1% of the rentals payable, depending on the term of the lease.

Furthermore, stamp duty is payable on documents executed outside PNG that relate to property or matters done or to be done within the country.