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Following the Money in the Extractives Sector Presentation to African Centre for Media Excellence

08 February 2012

Agenda
The current state of the Petroleum sector in Uganda The Legal and Regulatory environment General principles relating to the taxation of petroleum operations Capital gains tax on the transfer of an interest in a petroleum agreement General VAT principles Customs and import duties Gist of the current Government vs Heritage dispute Transfer pricing Proposals for the Oil money Questions?
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The current state of the petroleum sector in Uganda

Currently Uganda meets all its petroleum needs by way of imports at an estimated value of about USD 320 million per annum. This constitutes about 8% of the countrys total national imports. Its for this reason that the government is very keen to capitalise on the countrys confirmed petroleum reserves because of the importance of petroleum products in meeting national energy demands Update on Discoveries and Reserves

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The Legal &Regulatory environment

The Constitution of the Republic of Uganda, 1995; The Petroleum (Exploration and Production) Act, Cap 150; The Petroleum (Exploration and Production) (Conduct of Exploration Regulations 1993; Petroleum (Exploration, Development, Production and Value Addition) Bill, 2010 (will repeal the Petroleum and Production Act once passed into Law); Ministry of Energy & Mineral Development (through PEPD); Various new polices, legal and regulatory framework are currently in the pipeline for example The Revenue management law, The Resource Management Law, Fiscal Regime and Establishment of the Oil Revenue Fund.

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Hierarchy of the revenue share as contained in the PSAs

1. 2. Royalty The royalty is computed on the basis of gross daily production. Cost Recovery is in the form of cost oil Before sharing of production, the contractor is allowed to recover costs out of the gross oil revenues. PSAs place a limit on cost recovery and where the cost recovery exceeds the limit then the balance is carried forward and recovered in the following year of income. 3. Profit sharing The oil revenue that remains after the royalty and cost recovery is the profit oil, and this is shared between the contractor and the government through a pre- agreed profit sharing arrangement. 4. Taxes The contractors share of profit oil is then subject to tax at the corporation tax rate of 30%.
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Cost recovery

All the contractors exploration, development, production and operating expenditures as defined in the 8th Schedule are recovered as a % of the total gross oil production this is also called cost oil; For purposes of cost recovery, a ring fence applies around each contract area; If a contractor has more than one contract area, then cost recovery shall apply on a contract area by contract area basis; Most PSAs have a limit to the amount of costs that a contractor can recover, and if the actual costs incurred exceed the allowed limit, the balance is carried forward and recovered in future years against profits from that same contract area, and so on until fully recovered; The cost recovery limit ensures that the government gets a share of the profit in all circumstances where there is oil production.
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General principles relating to the taxation of contractors / licensees

Profit oil is split between the contractor and the government according to the terms of the PSA; According to the PSA, all taxes and duties shall be paid in accordance with the laws of Uganda; Taxes in issue are Corporation tax, Withholding tax, VAT and Customs The contractors share of the profit oil is subject to taxation at the corporate tax rate of 30%; The special provisions relating to the taxation of petroleum operations and the PSAs prevail over other parts of the Income Tax Act, in case of any inconsistency.
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Capital gains tax on transfer of an interest The amount of any gain arising from the disposal of an asset is the excess of the consideration received for the disposal over the cost base of the asset at the time of the disposal. The cost base of an asset is the amount paid or incurred by the taxpayer in respect of the asset including incidental expenditures of a capital nature incurred in acquiring the asset. Illustration

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Withholding tax on payments to non resident sub contractors in respect of Ugandan source services contracts
Is the payment being made by a contractor? Is the payment being made in respect of a Ugandan source services contract? Are the services provided by the non resident sub contractor directly related to petroleum operations? If Yes, Yes, Yes.then 15% withholding tax rate applies

But .. 1. Who is a non resident subcontractor?

2. What is a Ugandan source services contract? 3. Does the 15% withholding tax rate always apply? 4. What if the payment is being made to a sub contractor resident in a lower wht rate treaty country?
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General VAT Principles VAT obligations of non resident sub contractors

Non resident sub contractors may also have obligations for VAT in Uganda First step is to establish whether there is a supply being made or service being rendered in Uganda If yes, then whether that supply is subject to VAT If the contractor is making the payment for services rendered by the non resident sub contractor offshore is that an imported service? Who would be obliged to account for VAT in such a situation the non resident sub contractor (as a local supply) or the resident contractor (as an imported service)?

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Customs and Import duties

The exemption only applies at the time of importation of the goods into Uganda as a result of the Fifth Schedule of the EAC CMA; However, the local supply of such equipment by way of sale, lease or hire by a local supplier (sub contractor) to a contractor does not qualify as a VAT exempt supply ------ not in the Second Schedule of VAT Act; As a result when you import the equipment, no VAT applies, but when you buy, lease or hire the equipment locally VAT is payable; In order for a contractor to benefit from the VAT exemption they must import the goods themselves; Hiring the goods from a sub contractor and paying lease, hire or rental fees would give rise to VAT since the lease, hire and rental is not exempt from VAT;

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Gist of the current Government- Heritage Dispute

The dispute is in respect of an application by Heritage challenging an income tax assessment of US$ 404,925,000 arising out of a sale and purchase agreement where Heritage sold its 50% share in PSA to Tullow Issues raised were as follows; (i) Whether the sale of Heritages 50% interest to Tullow is taxable in Uganda (ii) Whether the URA assessment was proper (iii) What remedies were available to the parties.

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Gist of the current Government- Heritage Dispute Summary of URA Submissions

The applicant had sold an assignable interest in a PSA. The rights that were assigned were a right to explore, a right to search, a right to develop, a right to produce, a right to get samples a right to take oil and dispose of the oil produced from the designated areas in the PSA. The income was sourced in Uganda under Section 79(g) of ITA which provides that income is derived from sources in Uganda to the extent to which it is derived from the disposal of an interest in immovable property located in Uganda The purchase price was US$1,350M which was reduced by costs inform of signature bonuses of US$ 250,000 to obtain the capital gain of US$ 1,349M. 30% of the capital gain is the disputed tax liability of US$ 404M
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Gist of the current Government- Heritage Dispute Summary of URA Submissions

According to the URA, the exploration license was more than a mere permission to explore for oil in land The URA cited the case of Glenwood Lumber Co Limited V Phillip where Lord Davey said; it is not however a question of words but substance. If the effect of the instrument is to give the holder exclusive right of occupation of the land though subject to certain reservations or to a restriction of the purposes for which it may be used, it is in law, a demise of the land itself.

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Gist of the current Government- Heritage Dispute Summary of Heritage submissions

Proceeds received were not income derived from sources in Uganda. According to Heritage, Section 79 (g) of the ITA did not apply as the 50% participating interest sold was not an interest in immovable property. Heritage argued that a contractual licence or permission to search for petroleum does not create an interest in land. Heritage quoted the case of Thomas V Sorell where Vaughan CJ held that a dispensation of license property properly passeth no interest no alters or transfers property in anything but only makes an action lawful, which without it would have been unlawful
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Gist of the current Government- Heritage Dispute Contd TATs submissions;

The applicant had business in Uganda which qualified the company to be a taxpayer What was sold could only be ascertained by looking at Article 2.1 of the SPA which provided subject to the terms and conditions of this Agreement, the seller agrees to sell to the buyer and the Buyer agrees to purchase from the seller for the consideration set out in Article 3.1, the assigned interest Article 1 of the SPA defines assigned interest to mean all the sellers rights, titles and interests in the interest documents The tribunal agreed that Heritage sold its participatory interest to Tullow and the corresponding entitlements thereto and therefore earned income. According to the tribunal the sale of applicants rights and interest was a sale of property.
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Gist of the current Government- Heritage Dispute Contd TATs submissions;

In the absence of a statutory definition of immovable property, the tribunal resorted to rules of statutory interpretation to guide it to define an interest in immovable property under Section 79 (g) Blacks law dictionary 8th edition defined immovable property to mean property that can not be moved, an object so firmly attached to land that is regarded as part of the land. On this basis Blocks 1 and 3 A of the Albertine Graben were held to be pieces of land and therefore constituted immovable property. Having regard to all circumstances of the case, Heritage failed to satisfy the requirement that the assessment by the respondent as excessive and or erroneous and case was dismissed with costs to the respondent.
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Transfer Pricing
What is a Transfer Price? This is a price charged for goods and services between companies in the same group/related parties. Companies are able to shift profits between countries using transfer prices. This can be done by way of overcharging /undercharging. The tax law requires that transactions between related parties are conducted at arms length. This means that the prices that related parties charge each other for goods and services should be similar to the prices that would have been charged between independent parties to the transaction.

Why are tax authorities concerned?

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Transfer Pricing Illustration

Company A Distributor (Mauritius)

Owned 100%

Sale of Cars UGX 80 million

Company B Manufacturer of Cars (Uganda) Sale of cars at UGX 100 million

Company C Independent Distributor (Kenya)

Uganda tax rate 30%

Uganda Revenue Authority loses tax on the UGX 20 Million revenue. If the transactions are not at arms length, tax authority can adjust prices to reflect the price that would have been charged in a similar arms length transaction.

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How best Uganda can use the revenues accrued

National Oil and Gas Policy- goal to use the countrys oil and gas resources to contribute to early achievement of poverty eradication and create lasting value to society. Government plans to establish a rules-based framework to balance the need to spend against the need to save oil revenues for the future. Immediate goals are infrastructure, refinery etc

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Questions?

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Government may have no control over the gifts of nature but they do control taxes, and will use the tax system to maximize benefits to the country

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