Taxation of Petroleum Operations. This Oil is Hot!

We all would like to have a good tax avoidance plan. And respect a very good one and the person who made it when we come across it, until the plan treads the waters of uncertainty. Has Heritage Oil waded into the waters of uncertainty?

Below are some excerpts from the story ‘Oil extraction hits a snag’ covered by Ibrahim Kasiita in the New Vision Newspaper dated June 19 2010. The most eye-catching issue for the rest of us, who are not directly involved in the negotiations, was the large amounts of money involved.

“A plan to start extracting and refining Uganda’s oil has hit a snag due to tax disagreements between an exploration company and the Government. Heritage Oil and Gas Company Ltd has to sell its interests to a richer company that has the resources to extract and refine the oil but does not want to pay taxes on the sale. The Government on the other hand, insists Heritage has to pay the capital gain tax amounting to over 800b. Heritage is now seeking arbitration with the London based United Nations Commission for International Trade Law (UNCITRAL), a process that usually takes years…

Heritage wants to sell its interest in oil blocks 1 and 3A to either Italian giant ENI spa or Tullow Oil and is supposed to earn $1.5b from the sale. The transaction requires that a prospective buyer immediately pays $1.35b and a further $150m or surrender a stake in a producing oil field of a similar value within two years. But after negotiations with Government collapsed, Heritage on Thursday, issued a statement saying the sale could not start immediately.

“Heritage’s position based on comprehensive advice from leading tax experts in Uganda, the United Kingdom and North America, is that the disposal of the assets is not taxable in Uganda,” the company said. Heritage argues that they are not under obligation to pay tax. But it has also offered to deposit $108 with the Uganda Revenue Authority (URA) on receipt of the payment from its transaction, which would be refunded to Heritage if it is ultimately determined that no tax is payable. The United Kingdom-based company claimed that the offer of $108m was based on Uganda’s Income Tax Act, which requires a taxpayer to deposit 30% of the disputed amount of tax with the URA pending final resolution of the dispute.

So far, there is no reference to the double taxation agreement between Uganda and the United Kingdom or the source and residence rules that govern International tax matters. And there is also no mention of a tax waiver under any incentive scheme to promote economic development under which Heritage would benefit.

Heritage Oil is willing to remit 30% of the disputed tax to the URA as stipulated under section 103 (2) of the Income Tax Act Cap 340 (ITA) which it will be refunded if heritage is found to be exempt from tax. But this percentage is supported under section 100 of the ITA only if the appeal is to the Uganda Tax Appeals tribunal which is under the jurisdiction of the Constitution of the Republic of Uganda. The question raised is why is Heritage Oil is bothering with the 30% of the tax assessed if it is seeking arbitration with UNCITRAL?

It is interesting to note that in all the articles availed to the Ugandan public, maybe by omission, Heritage Oil has not yet quoted any sections of the Law under which they are not obliged to pay tax. In the Uganda Income Tax Act Cap 340, sections 49 to 54 are clear on the laws governing the gains and losses on disposal of assets, and capital gains tax would arise on the sale of Heritage’s interest in Oil blocks 1 and 3A.

However, there is PART IXA on special provisions for the taxation of petroleum operations, which was inserted into the Income Tax Act in 2008 and its section 89G stipulates that no gain or loss is taken into account on the transfer of interest in a petroleum agreement. These special provisions for the taxation of petroleum operations were inserted in the year 2008 and back dated to the effective date of 1st July 1997.

Whereas the Financial Times quoted Energy Minister Hilary Onek as saying Uganda “would not budge” and that, like any company in Uganda, Heritage was liable for the tax, section 89B of the ITA clearly states that were there is inconsistency between the other parts if the ITA and the special provisions for taxation of petroleum, the special provisions and the petroleum agreement will prevail. So there is a possibility that section 89G rendered capital gains tax on petroleum operations under sections 49 to 54 of the ITA obsolete.

The relevant sections of the ITA and the petroleum agreement, that has not been publicised, are still up for interpretation hence Heritage opting for arbitration.

But it is difficult to understand why such provisions for the taxation of petroleum were backdated to the year 1997 when the controversial issue of the transfer of interest in petroleum agreements was yet to arise. Whatever happened to ‘law grows with growth in society’?

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9 thoughts on “Taxation of Petroleum Operations. This Oil is Hot!”

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