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The Kampala Shuffle: Searching for Consistency in Uganda's Oil Capital Gains Tax Regime

26 August 2014
Author
Thomas Lassourd
Topics
Contract transparency and monitoringTax policy and revenue collection
Countries
GhanaGuineaTanzaniaUganda
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On July 16, 2014, the Tax Appeal Tribunal of Uganda ruled in favor of the Uganda Revenue Authority (URA) in its suit against Tullow Oil. The tribunal held that Tullow must pay $407 million in capital gains tax (CGT) to the state following the farm-down of 66 percent of its assets in Uganda to international oil companies CNOOC and Total for $2.9 billion in February 2012. (A farm-down is an assignment of part or all of an oil, natural gas or mineral interest to a third party, a common operation for oil companies seeking additional investment in a particular operation.)

Tullow had argued that a large part of the assets sold were covered by a stabilized production sharing agreement (PSA) that exempted the company from capital gains tax. The PSA was signed in 2001 by the then minister of energy and mining, whom the Tax Appeal Tribunal said lacked the legal authority to grant tax exemptions that only the URA had the powers to manage. Tullow has publicly commented on the July decision and announced it would seek to challenge the ruling through the Ugandan courts and international arbitration.

The settlement of this dispute could take years, but meanwhile the case highlights several challenges faced by emerging oil economies in Africa.

First, as previously articulated by oil sector analyst Keith Myers, there are strong arguments both for and against capital gains tax in the extractives context. Theoretically, it would be best to simply disregard capital gains for corporate tax purposes, for both buyer and seller. Not only would it be administratively easy, as there would be no deduction to account for in the buyer’s books, but according to classical economic theory it would allow the most capable investors to develop the resources. Even when a capital gains tax is deemed appropriate and administratively manageable, economic arguments support allowing the deduction of the seller’s capital gains tax to the buyer’s future income, in order to make the tax (almost) neutral to companies’ transactions.

However, the theory does not apply well in developing countries, where expectations from natural resource extraction are high, especially when substantial capital gains are made before production has even started and state revenue been generated. In such circumstances, huge windfalls from relatively short-term investments should legitimately be taxed by the state. This is why many jurisdictions in sub-Saharan Africa (e.g., Guinea in 2013) are strengthening capital gains taxation in the oil, gas and mining sectors.

The Natural Resource Governance Institute (NRGI) supports the development of a strong and predictable system to tax capital gains in the oil and mining sectors in Uganda. However, a balance needs to be struck between putting the right fiscal regime in place in the immediate term and creating an environment in which the risk perceived by investors is sufficiently moderate. If investors demand a lower risk premium when committing billions of dollars of capital, the government can extract better fiscal terms when awarding new blocks of oil. The predictability of the fiscal regime is important to investors. In this respect, with three consecutive changes to its capital gains tax regime between 2008 and 2010, Uganda did not send positive signals to investors, a conclusion that industry representative Emmanuel Mugarura also reached in a recent column. Going forward, if the current regime is deemed acceptable, the government and companies should support it so that it can become a predictable standard.

Second, as highlighted in another recent column, this decision by a Uganda court could signal the end of the era of tax waivers unilaterally granted by ministries that essentially work in silos. Over the past twenty years, agricultural, tourism and extractive ministries in countries like Uganda and Tanzania have granted tax exemptions without approval from the governments’ finance and tax departments. Most importantly, tax exemptions were not subject to a proper assessment weighing the benefits in increased investments versus the opportunity costs to the treasury. The recent ruling should prompt resource and finance ministries to work together on consolidating the revenue-generating potential of extractive industries.

Finally, what is striking in this case is that while the controversy is very much in the public domain, information that would allow Ugandan citizens to form an independent opinion and hold their government to account is not. Publishing contracts is an efficient way to signal to the investor community a level playing field and a stable legislative environment—but the Ugandan government has resisted the publication of all PSAs signed with oil companies, despite calls from national and international actors for contract disclosure. It is not too late for the government of Uganda to embrace natural resource transparency and systematically publish oil and mining contracts, as many other African governments (including Guinea, Liberia, Niger and Sierra Leone) are beginning to do.

Sponsoring a systematic and standardized disclosure of oil and mining contracts, the government of Uganda would also increase the country’s attractiveness as an investment destination and reduce perceived risk by oil and gas companies. And if Uganda were to join the Extractive Industries Transparency Initiative it would automatically create a useful multi-stakeholder forum in which to develop such a policy.

Thomas Lassourd is an economic analyst with NRGI.

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