Pay the tax money or get out

“Super Profits” at Stake

At stake in the wrangle is what Uganda claims as its share of one of the top earning oil and gas deals in the world.  Over its 11 years operating in Uganda, Heritage Oil Plc of the UK incurred only US$150 million costs in its exploration venture in the country. Heritage sold its shares to partner Tullow for US$1.5 billion, an amount that Energy Minister Hilary Onek has called a “super profit.”

Following the sale of Heritage’s shares in blocks 1 and 3A, Uganda insists it should have been paid 30 percent Capital Gains Tax, equivalent to about US$450 million. Instead, only US$128 million was paid to Uganda and the outstanding amount of $281 million deposited in a London escrow account.  With the sale of its assets, Heritage earned US$9 for every one dollar invested.

According to an analysis produced for the Revenue Watch Institute by energy expert Keith Myers, that is among the top three most profitable oil and gas transactions in the world in the last five years when measured according to rate of return for the companies involved.  Only Burren Energy and Emerald have earned larger rates of return in the last five years, walking away from projects with US$25 and US$12 for every dollar invested respectively.

The money earned by Heritage also represents the first fruits of an industry whose profits Ugandans are already salivating for.  Since the discovery of oil two years ago, politicians, the media and the companies operating here have hyped the public`s expectations of oil; the government does not want to disappoint.

As production is still a year away and the country is yet to see any revenues from oil, the thought of multi-national companies making billions on Uganda’s national resources without the country gleaning even crumbs is unpalatable.  “It is hard for politicians to explain (to the public) how large profits have been made on national assets without any taxes yet being paid,” said Myers in his analysis.

If the tax dispute in its deal with Heritage is resolved,  Tullow hopes to rake in up to US$ 3 billion from its farm down of Block 2 to CNOOC and Total . The government hopes to take in an equally large sum in taxes on that transaction.

Also hanging in the balance is the government’s authority over the industry; collecting tax would show both Uganda and the world who is calling the shots on oil.  President Museveni’s hopes for first oil before the election may have failed along with an early production scheme, but a fat tax cheque would demonstrate to Ugandans that the government will not let all the profits of oil be leached out of the country by foreigners.  It would also send a strong signal to multinational corporations that the government will not let itself be pushed around.

Eyes on Tullow

Since Heritage sold its assets and absconded from the country, fairly or unfairly, the government has been looking to Tullow to rectify the problem.  In his letter to Minister Onek dated Aug. 10, the President says that the most “straight forward” way to resolve the issue would be for Tullow to pay Heritage’s outstanding taxes and then recover the money from its former partner later.

Other senior members of government have also said publicly that Uganda is looking to Tullow to help collect tax from Heritage.  “We have asked Tullow to trace Heritage to ensure that all taxes due to government are paid,” said Peter Lokeris, Minister of State for Minerals.

Minister of State for Energy, Simon D’Ujanga, explains that according to Ugandan tax law, “if you go into a transaction over something that attracts tax, the URA can appoint you to collect tax.”  The company made a mistake in buying from Heritage while the tax issue remained unresolved, according to D’Ujanga.   “Tullow, buying with the knowledge that this would attract tax, should not have paid the full amount.”

If forced to pay the Uganda government on Heritage’s behalf, Tullow may be able to recover the money.  A legal expert says it is likely that Tullow has a clause in its sale agreement with Heritage for the recovery of any taxes, including Capital Gains Tax, incurred in the sale.  That would allow for the release of the money in the London escrow account to pay the Ugandan government.

In a Corner

Throughout the dispute, Tullow officials have maintained that the issue of Heritage’s unpaid tax should be de-linked from the farm down of their assets to the Chinese CNOOC and French Total.  However, with the repossession of Kingfisher field, the government has drawn Tullow back into the fray.

Tullow declined to provide comment for this story except to say that discussions with the government are ongoing.  However, at a Sept. 30 conference in South Africa, the company’s Chief Geoscientist, Paul Burden, admitted that the dispute is “between the government and Tullow now that Heritage has exited.”  Furthermore, in a statement of results on Aug.25, the company said “that the government has indicated that they will not grant a license extension until the tax matter is resolved.”

Legal analysts say the government was well within its rights to repossess the block since Tullow had not submitted a field development plan and applied for a license for Kingfisher in time.  The company should have applied for a production license by February 2010, two years from when oil was discovered in the field, in 2008.  If the cost of getting Kingfisher back is the outstanding taxes, it is well worth it for Tullow to pay; Heritage’s outstanding taxes amount to US$281 million, while the company expects production in Uganda to amount to 200,000 barrels of oil per day at its peak.

Clearing the taxes may also be the cost of getting back in the President’s good graces.  Those informed about the negotiations say that the Irish company has fallen out of favour with the President over the transaction.  The President is apparently incensed that the company went ahead and paid Heritage before it had the full approval of the government.  That’s made it very hard for the company to operate in Uganda.  Now “every door (in government) they go to is closed,” said one industry source.

Dickens Kamugisha, of the African Institute for Energy Governance, says he believes that Museveni’s frustration with the Irish company dates back even further than that.  “Since they have failed to follow the early production scheme, he is annoyed with Tullow,” he said.  It’s believed that Museveni wanted to see the first oil flowing before the 2011 election.

Keeping out of International Court

In pressing Tullow for a solution to the tax problem, the government is aiming to avoid being forced into arbitration in London by Heritage.  The government has consistently refused Heritage`s offers of arbitration in London, maintaining that outsiders should not be making decisions about a Ugandan national resource.  Minister Onek told the media, “The oil fields are not in London.  They [Heritage] are doing business here based on a national asset.  They are obliged to pay the tax.”

If negotiations break down and one of the companies calls for arbitration, Uganda will be compelled to go.  According to those who have seen the Production Sharing Agreements (PSAs), all of Uganda’s contracts with oil companies contain a clause that states that disputes are subject to non-limiting arbitration before a board in London.

The government is not optimistic about its chances of winning in a court outside the country.  This is despite the fact that the tax laws in place when the PSAs were signed call for Capital Gains Tax to be levied and the PSAs contain a clause that states that all tax matters are to be decided in accordance with Ugandan law.

Uganda`s Solicitor General has advised the government not to go to arbitration, suggesting he fears the government does not have a good case.  Perhaps his analysis of the PSAs has revealed another factor that weakens Uganda’s argument.  Or perhaps Uganda’s past losses at arbitration make him nervous about going to court again.

A defeat at arbitration would certainly set a dangerous precedent for Uganda.  If the court finds that Heritage does not have to pay tax, every other company doing business in the country could subsequently argue that they should not have to either.

It’s not yet certain how the dispute over Heritage’s unpaid taxes will be resolved.  As the wrangle gets bigger, drawing in Tullow and later maybe, oil majors from around the world, the one thing that is clear is that many people consider the reserves in Uganda worth fighting over.