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The East African : Aug 25th 2014
The EastAfrican OUTLOOK AUGUST 23-29,2014 region could alienate investors, delay projects KENYA FINALLY GETTING ITS DUCKS IN A ROW With potential discoveries of commercial oil reserves onshore and offshore, Kenya appeared to be headed in the wrong direction. However, after listening to the IOCs, understanding the unique aspects of the industry and perhaps realising the negative consequences that policy and legislative changes would have, the country now appears to have found its bearings. Kenya had introduced a 10 per cent tax on farm-out transactions. This meant that in addition to reimbursing the person/company farming out a proportionate amount of his past costs based on the interest acquired, the person/company acquiring the interest was required to factor in the additional cost. Exploration activities are risky and expensive, which is one of the reasons governments invite IOCs to undertake them. IOCs in turn enter into farm-out agreements to mitigate risks and acquire funds necessary for exploration activities. In farmout agreements, the IOC invites the person farming-in to participate in the impending risk by assigning him an interest in the block in return for the conduct of, or payment for drilling or testing operations on that acreage. Imposing the 10 per cent tax made farm-out agreements more expensive, and Kenya unattractive. Kenya has proposed to overhaul its legislation relating to the taxation of upstream, midstream and downstream operations. The proposed changes, which are supposed to take effect from January 1, 2015, seek to harmonise the provisions in Kenya’s Income Tax Act with those in the PSAs that the government has signed with IOCs. Once the proposals are enacted, tax THE NUMBERS 25pc Amount by which oil reserves in Africa have grown in the past 20 years, while gas reserves have grown by over 100 per cent. 6pc Annual average rate by which oil production on the continent is expected to rise in the foreseeable future. 91.5pc Share of proven natural gas reserves of four countries in Africa — Algeria, Egypt, Libya and Nigeria. TANZANIA, A CASE OF SHOOTING ITSELF IN THE FOOT IOCs operating in Tanzania have had their fair share of hiccups ranging from enforceability of their PSA provisions to interpretation of the law. One such example is the confusion created by the Tanzania Revenue Authority on the application of withholding tax on payments relating to persons living outside Tanzania for services that they performed while in the country. This provision is aimed at bringing Tanzanian non-residents — who provide services (and consequently earn income from Tanzania) and then leave without paying taxes — into the tax net. Unfortunately, Tanzanian tax authorities have interpreted withholding tax on service fees from a payment perspective as opposed to source perspective as required by the wording used in the legislation. TRA contends that service payments have a source in Tanzania (and are, therefore, subject to the 15 per cent withholding tax). They have disregarded the source rules, which require the services to be rendered in Tanzania by a non-resident for withholding tax to apply. This erroneous interpretation by the TRA, which the tax adjudication bodies have acquiesced, has generated confusion as far as services are concerned, and left the IOCs between a rock and a hard place with regard to paying their will be imposed on any gain that is realised from farm-out transactions. In addition, where there is a direct or indirect disposal of shares in an IOC having an interest in Kenya, the net gain in such transactions will be subject to tax in a manner similar to a farm-out transaction. The proposed law also clarifies how future work obligations will be treated for tax purposes. Turkana Governor Josephat Nanok, Tullow Kenya country manager Martin Mbogo and British High Commissioner to Kenya Dr Christian Turner tour Tullow Oil’s Ngamia 3 oil exploration site in Turkana South, northern Kenya on July 13. Picture: Billy Mutai Not surprising, the additional 10 per cent cost has contributed to a decline in drilling activities in Kenya, and since 2010, there have been no farm-out transactions. However, it is anticipated that the revamped Ninth Schedule under the Income Tax Act will help spur activity in Kenya’s oil and gas sector. It is also commendable that though Kenya enacted a new VAT Act, favourable provisions that had been enacted to encourage growth in the sector were retained. 31 Lesson from Papua New Guinea East African countries could borrow from Papua New Guinea the kind of policies to create an enabling environment that have helped the country export its first LNG cargo ahead of schedule. To be fair, discoveries in Papua New Guinea were made almost 30 years ago and the process of putting up an LNG facility has been plagued by challenges, most of which were outside the country’s control. However, once everything was in place, it took seven years between initiation of an LNG feasibility report (in 2007) and the first shipment of LNG (this year). It is disappointing and perhaps difficult to comprehend that the oil dis- sub-contractors for services rendered. The IOCs services contracts with their non-resident service providers are now 15 per cent more expensive. IOCs have also expressed their concerns about the proposed VAT Act 2014, which is to be tabled before Parliament later this year. The Act proposes to repeal the current VAT legislation and introduce a new law that seeks to restrict tax exemptions. While goods and services procured by IOCs in relation to exploration activities currently enjoy VAT exemptions, one of the changes proposed in the VAT Act 2014 is restricting the exemption to only goods imported for exploration activities. The oil and gas sector will certainly be affected negatively by this and other changes in the proposed VAT Act 2014. In addition, the removal of VAT relief on capital items with the IOCs planning an onshore LNG processing facility has meant that IOCs are currently re-evaluating the economic dynamics of their future investment decisions. While ideally the VAT should not be a business cost, the uncertainty in the turn around time between lodging VAT refund claims and receiving the money from the government means that the IOCs have to factor in unnecessary cash-flow costs in their financial modelling for exploration activities and the LNG processing facility. The misunderstanding about farm-out Songo Songo gas plant in Tanzania. Picture: File transactions and whether they constitute a sale of shares or assets has manifested itself in Tanzania with the TRA adopting the position that a farm-out transaction constitutes a disposal of an investment (shares) and have gone ahead to demand 30 per cent tax on a couple of farm-out transactions. The motivating factors for a farm-out agreement include drilling so as to fulfil PSA continuous development clauses, sharing risk, sharing coveries in Ghana and in Uganda were made at around the same time. Ghana is now an exporter of oil while the dynamics in Uganda have taken a turn for the worse, and it is still uncertain whether international oil companies will Retrogressive and uninformed legislative changes, refusal to honour agreements and adopting policies that paint the region as unstable and unpredictable could delay oil and gas projects want to bring their projects to fruition. No business person seeks out the most expensive, unpredictable and unstable place to set up shop. Retrogressive and uninformed legislative changes, refusal to honour agreements and adopting policies that paint the region as unstable and unpredictable only delay such projects, and could make capital-intensive oil and gas related projects economically unviable for the region. Joseph Thogo is a senior tax manager with Deloitte East Africa based in Tanzania. The views expressed here do not necessarily represent those of Deloitte. of geological information etc. Seeking to tax farm-out transaction discourages IOCs from farming-in, which means that exploration campaigns are rescheduled or cancelled altogether. Tanzania should borrow a leaf from Kenya regarding the treatment of farm-out transactions. The Tanzanian oil and gas industry has been relatively calm and stable, and the fruits of this can be seen from the planned joint LNG facility, which is currently in the planning stage. However, the waters seem to be getting rough as evidenced from the policy and legislative changes and also from the feedback from the fourth licensing round. The fourth licensing round was based on the 2013 Model PSA, and there were seven deepsea offshore blocks and one in Lake Tanganyika on offer. While the results of the licensing round are yet to be released, the feedback is that the 2013 Model PSA is unfavourable, which would explain why there were no bids submitted for four offshore blocks, and the blocks where bids were submitted only received conditional offers. Even though there has been a lot of buzz about offshore gas discoveries, Tanzania cannot afford to be overly bullish about them. Unfavourable PSA terms will deter prospective interest from IOCs, particularly with regard to offshore exploration, which is more expensive and risky.
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