Partners fail to agree on who should bear tax burden owed to the government.
Will finding a new investor solve the $185 million question? This is the emerging issue after the collapse of a farmdown deal between Tullow and joint venture partners Total E&P and China National Offshore Oil Company (CNOOC) over a tax dispute.
The complication surrounding the tax issue is critical to Uganda which, having de-risked the oil and gas sector because of high discovery rates at over 80 per cent, is now challenged to assure investors of a good business environment.
Tullow announced it terminated the farmdown on August 29, 2019 after the Sale and Purchase Agreement (SPA) expired without the buyers of its shares on offer—Total E&P and partner CNOOC showing interest to have it extended.
Apparently, Total and CNOOC failed to align their positions with the Uganda government over the $185 million capital gains tax equivalent to 30 per cent of $617 million which is the overall investment by Tullow in the country’s oil and gas sector.
“Since 2017, all parties have been actively progressing the SPA. Despite diligent discussions with the authorities, no agreement on the fiscal treatment of the transaction has been reached. The deadline for closing the transaction has been extended several times, clearly demonstrating the endeavours of the parties to find an agreement,” said Total’s president for exploration and production Arnaud Breuillac.
Joint venture partnership
Tullow announced it signed an SPA on January 1, 2017 with Total E&P to transfer 21.57 per cent from its 33.33 per cent interests in the joint venture partnership. Tullow was the official operator of exploration areas 1, 1 A, 2 and 3.
Each of the joint venture partners holds equal shares of 33.33 per cent in all of Uganda’s discoveries.
However, on March 17, Tullow informed the Uganda government that CNOOC had exercised its pre-emptive right to claim a 50 per cent stake in Total’s buy as provided in the joint operating agreements.
Successful completion of the farm-down would have implied that Total and CNOOC would have each increased their interests to 44.1 per cent while Tullow would have kept 11.8 per cent. This transaction was valued at $900 million. The URA then assessed a tax of $167 million after protracted dialogue.
A twist, however, developed when URA assessed tax on $617 million Tullow’s investment.
No agreement has been reached, a development that will cause further delay to reaching Final Investment Decision. It also raises the question whether the next investor will agree to paying the taxes.
Under the existing tax regimes and Production Sharing Agreement, the $617 million is recoverable and tax deductible.
Total and CNOOC argued that if Tullow had not opted to sell part of its interests, it would have recovered the amount when oil production begins without being taxed on the recovery of the cost.
The companies wanted the overall cost of $617 million treated as a recoverable and deductible, meaning that it does not attract additional capital gains tax.
But Uganda will not budge: The taxman wants the already assessed $167 million in capital gains tax, but does not want to transfer tax deductions of the $617 million to Total and CNOOC, the buyers of Tullow’s shares.