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Why Uganda should reconsider oil tax amendment

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Added 10th November 2017 11:43 AM

Oil companies will not only pay income taxes at the onset of oil production

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By Denis Kakembo

A new law that will see oil companies pay income tax at the onset of oil production whether they are in a profitable position or not was recently assented to by the President. Though this change fast-tracks Government revenues, it is punitive to the oil companies compared with the other sectors of the economy. Given the range of alternative fiscal tools the Government can use to maximise early oil revenues, this article recommends a review of this amendment (i.e. the Income Tax (Amendment) Act 2017, which amended section 89GA of the Income Tax Act, Cap. 340).    

Massive and complex commercial undertaking   

Unless developed and monetised, petroleum discoveries remain aground. Building the infrastructure to enable oil production is a massive, complex and expensive commercial undertaking. While it is widely expected Uganda will shortly proceed to develop this infrastructure, the oil companies are yet to make a final investment decision (FID). FID is an important milestone as it signifies an irreversible commitment by the investors to undertake the project.

The FID is largely informed by commercial considerations. Investors commit capital to commercially viable ventures. A project is viable, if the investment can be recovered with a commensurate return within specified timelines. Project viability financial measures include but are not limited to the duration it takes to recover an investment also known as the payback period. The proposal to have oil companies pay income taxes at the onset of oil production may delay the project payback period. 

Sector enabling tax changes in 2015   

The Government revised petroleum tax laws in 2015 cognizant of their impact on the commercial viability of Uganda’s oil projects. Oil companies were allowed a full deduction of their business costs ensuring they pay income taxes only when profitable. Exposure to VAT during the investment cycle of these projects was also mitigated. These measures were lauded by sector experts as facilitating the commercial viability and bankability of Uganda’s imminent oil and gas projects.

The amendment is unnecessary

The government has reinstated the pre-2015 position that will see oil companies pay income taxes at the start of oil production regardless of whether they are in a profitable position or not. While Government revenues will be accelerated, there are other better suited fiscal instruments to achieve this objective that can be explored.

Income taxes are ordinarily imposed on profits. Companies in other sectors are allowed a full deduction of their business costs in determining their income tax liability. Denying the oil companies full deduction of their annual business expenses departs materially from the normal principles of income taxation and international benchmarks. 

Oil companies will not only pay income taxes at the onset of oil production. They are also likely to be in a perpetual income tax paying position because of the caps introduced on the deduction of their annual business expenses. In view of the significant expenditure incurred early in the life of petroleum projects, oil companies may never be able to utilise all the tax losses that will arise prior to generating cash flows during the exploration and development stages.    

Project payback will also be delayed as companies will prioritise income tax payments even though they are not technically profitable. Debt repayments to project lenders in the early years of oil production may be delayed because of the cash flow constraints likely to be imposed by this change. Lenders can revisit their commitment to provide funding for this project or price their capital more expensively the reason project take off can abort. 

Accelerating early oil revenues

Crude oil discovery and production usually heightens citizen’s expectations of an economic bonanza. Unless managed with realistic projections, the Government of the day can find itself under immense pressure to fast-track oil revenues in the short term even though this affects the long term viability of the sector. 

Uganda’s petroleum fiscal regime incorporates royalties that enable the Government to receive revenues at the start of oil production. There is also a cap to the costs incurred by oil companies that can be recovered each year giving the Government a steady flow of revenues even before the projects are profitable. There are additional levies payable annually to the Government by the oil companies not necessarily related to production or profitability. These measures are better suited to accelerate early oil revenues than the new tax changes. 

Conclusion

Current Government measures should be focused at unlocking the expected investment in the oil and gas sector. While significant investment will be made in the next three years, if the oil companies proceed with this project, there will be more benefits with the commencement of oil production. The development of petroleum discoveries will provide direct and indirect jobs; enable workforce training, local supplier development as well as expanding the tax base.

Any potential obstacles to Uganda’s crude oil production should, therefore, be eliminated or avoided.  

Writer is a legal and tax expert

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