The victory of Uganda Revenue Authority over Tullow Uganda Ltd and Tullow Operational Pty Ltd in a legal battle at the Uganda Tax Appeals Tribunal has important lessons for African revenue administrations, governments and businesses.

The issue in contention was whether the Production Sharing Agreement (PSA) signed between the appellants and the Ministry of Energy and Mineral Development covered exemption from capital gains tax arising from disposal of interests in the PSA.

The tribunal found the exemption invalid under Uganda tax laws and the appellants were not entitled to the said exemption. The Tribunal therefore ordered the appellants to pay capital gains tax of $407,095,366. This is a victory in the fight against tax base erosion.

African countries face a wide range of challenges in the effective taxation of different business segments, with resultant loss of revenue.

The challenges of taxing the informal sector, small and medium enterprises and multinational enterprises cannot be overemphasised. This is the cause of first level revenue haemorrhage.

The situation has been aggravated further by harmful competition for investments occasioning granting of inappropriate and wasteful tax incentives.

A recent OECD report showed that on average, incentives amounted to 33 per cent of the total value of tax collection in some African countries.

All these factors combine to substantially erode the African tax base. The situation must be reversed if African has to attain self-sufficiency in domestic resource mobilisation.

The recent heightened discovery of mineral resources on the African continent pose new challenges that are a direct threat to the African tax base as attested by the URA case.

Taxation of these resources is different from other taxes as it is essentially effected by way of splitting profits with a partner who has the capacity to extract, refine and sell the resources.

If the tax regime does not split the profits appropriately, there may be a significant loss of revenue. Such agreements can be beneficial to countries that lack the expertise and capital to exploit their resources.

Production sharing agreements are new to emerging producers of extractive resources on the continent. This poses a major challenge when it comes to signing such treaties as the continent is still in the process of developing expertise.

Unless countries take extra care, they run the risk of signing away millions of dollars through poor resource contacts.

In addition, such contracts can contain hidden clauses that if not scrutinised carefully may lead to further illicit financial flows through granting of ill-conceived tax incentives. This is the situation the URA found itself in.

In the PSA, Uganda’s Energy Ministry granted, under Article 23.5 of the agreement, waiver of tax arising from assignment or transfer of interest.

In my understanding, the spirit of the waiver was to enable licensees to bring on board partners to share risks without needing to pay fees and levies upon transfer of rights.

However, the contract seems to have been  crafted to include waiver of capital gains tax, which is not a transfer tax, and thus its exemption cannot covered by the article.

Capital gains in Uganda are covered under the Income Tax Act, which is administered by the minister for finance who clearly played no role in granting the incentive in dispute.

The ruling in favour of URA is a wake-up call for government agencies that have been operating as silos in signing tax concessions without giving statutory considerations due attention.

It is common practice among a number of developing countries for individual government departments to grant waivers of taxes to attract investments without due regard for statutes that govern taxation.

A modern tax system requires a co-ordinated approach towards granting such waivers. It is important that African countries put in place appropriate transparency and governance procedures for granting of tax incentives to ensure that all interested parties are aware of incentives being granted and why they are being granted.

The question that comes to many people’s minds is whether this verdict puts in question the legality of other such exemptions. I am of the opinion that one ought not to worry about the legality of exemptions granted but rather their correct interpretation and application.

Having advanced rulings often sorts this out. The case sets a judicial precedent that will guide relevant state agencies across the continent in handling similar cases.

Mineral exploitation companies need to engage with tax authorities in advance when making legal interpretations that impact on tax obligations. This will cushion them against unforeseen tax liabilities and fictitious tax benefits.

Logan Wort is the executive secretary of the Pretoria-based African Tax Administration Forum, the umbrella body of African tax administrations.