The main economic value from oil companies to host countries is from oil production revenues and income taxes on the oil company’s profits.
“The biggest single contribution by far that we make is the tax we pay,” said Simon Thompson, Chairman Tullow Oil while commenting on the importance of revenue transparency in Ghana in 2015.
However, multinational companies generally don’t pay the taxes they should be paying to host countries in order to maximize their profits, especially after the 2008 financial crisis. Uganda has already had firsthand experience.
In what remains Uganda’s biggest court case ever, Uganda Revenue Authority battled Heritage Oil and Gas Limited in a $404 million tax dispute to secure her fair share of revenue in form of Capital Gains Tax. Heritage attempted to exploit loopholes in Uganda’s tax regime to avoid the imposition of a 30% capital gains tax upon completion of $1.45 billion sale of its 50% interest in Blocks 1 and 3A of Uganda’s oil resource to Tullow Uganda Limited in July, 2010.
Among other contentious issues before the Tax Appeals Tribunal in the initial stages of that legal battle, was the interpretation of separate words; interest and immovable property, and the definition of Capital Gains Tax. In their judgement, the tribunal ruled that “the sale of the applicant’s rights and interests was a sale of property” and that the thin line between the perceptions of the words is so blurred that they could be used interchangeably. The Tribunal faced another hurdle of defining Capital Gains Tax. Uganda’s Income Tax Act neither mentions nor defines it.
The three-man tribunal sought for the answer from an old English adage: If it looks like a duck, walks like a duck, quacks like a duck it must be a duck. The tribunal further explained that “it would be appropriate to say that the tax on gains received from the disposal of a business asset or capital gains in the nature of trade taxed is Capital Gains Tax.” This ruling was upheld by the commercial court and the protracted legal battle was resolved four years later in the Commercial and Arbitrary Court, London, in favor of Uganda.
Documents leaked as part of the Panama Papers revealed that in addition to pressing the government not to impose the tax, the company re-domiciled from the tax haven of the Bahamas that did not have a double taxation treaty with Uganda, to the tax haven of Mauritius, which did. Heritage Oil and Gas Limited was incorporated in Mauritius on 15 March 2010.
Heritage’s tax evasion attempt in Uganda wasn’t surprising. Multinationals employ very aggressive tax avoidance strategies, and this has caused outrage in both rich and poor countries. The extractives sector is significantly affected. Countries rich in oil, gas and minerals often fail to secure the fair share of their natural resource wealth.
Research on Illicit Financial Flows (IFFs) in Africa has concluded that the main source of government revenue loss is neither smuggling nor corruption but rather company tax avoidance. IFFs are a shared problem between developed and developing countries. Despite the limitations in determining the exact revenue losses to illicit financial flows, research shows that global revenue losses to corporate taxation range from $500 billion to $650 billion; the estimated loss ranges from 6 to 13 percent of total tax revenue in developing countries, versus 2 to 3 percent in OECD countries.
Securing a fair share of government revenue from extractive sector projects is a two-step process: establishing a fair tax rate for the project at the outset, and then protecting the tax base over the lifespan of the operation. Shortcomings on either front can result in a significant loss of government revenue.
Whereas the Government of Uganda and the civil society have so far both prioritized ensuring that the people of Uganda receive a fair share of their oil revenue, protecting oil revenues requires constant vigilance.
So, as Uganda’s oil projects transition from exploration to project development and ultimate oil production, an anticipatory risk assessment is particularly strategic for Uganda to help close potential avenues for revenue leakage.
Uganda’s oil production and export is governed by fiscal terms agreed upon by Joint Venture partners, and government in Production Sharing Agreements (PSAs), as well as, the revisions to the Income Tax Act (Special Provisions for the Taxation of Petroleum Operations). A total of nine Production Sharing Agreements (PSAs) were signed between 2001 and 2012. Recently the EACOP tripartite agreements (Host Government Agreements, Shareholding Agreement, Tariffs and Transportation Agreement) were signed in the presence of two Heads of State.
The fiscal terms contained in these PSAs can generate a reasonable share of revenue for Uganda. However, there’s a contrast between the theoretical performance of a fiscal regime and its performance in practice. It’s wrong to assume perfect performance of the fiscal regime until they are put to a reality test.
Whereas the headline terms—categories of tax and corresponding percentage payable to government— tend to attract more attention than the fiscal regimes, IOCs opt for tax base erosion. This is oftentimes enabled by the complex cooperate structure adopted by multinational corporations.
How then do oil companies evade tax and how can this be detected? We return to this next week….
NOTE: Mr. Twinamatsiko is is a Research Fellow focusing on Strategic Minerals and Oil Governance and Cyber Policy and Digital Rights programs at Great LakesInstitute of Strategic Studies. This Op-Ed is adopted from a paper he first discussed at the Policy Roundtables and Insights of the institute. He can be reached at news@mediascapenews.com.