Taxation is one of the most challenging issues when it comes to the oil and gas industry. But the Guyana Revenue Authority (GRA) maintains that it is quite alert when it comes to the tax avoidance tricks of oil and gas companies.
This assertion was recently made by GRA Commissioner General, Godfrey S. Statia.
He noted that despite the gloom and doom expressed by numerous persons and many experts in the field, the Guyana Revenue Authority, which is the premier tax collection agency in Guyana, has embarked on a program to ensure that the nation benefits from every activity associated with first oil; be it at the upstream (the license or the concession stage, exploratory, appraisal, developmental, production and abandonment phases); the midstream; or the downstream activities – (refining, processing, marketing and distribution).
Statia noted that Governments of oil producing countries, when designing the tax regime of “first oil”, face the challenge of ensuring a fair share of revenues for their country, while at the same time providing sufficient incentives to encourage investment.
The Chartered Accountant said that this has caused governments around the world to employ either the concessionary system or the contractual system of taxation or a hybrid of both. He noted that developed countries tend to employ the Tax and Royalty regime which are concessionary in nature (UK, Norway and Australia), while developing countries (India, China and Guyana) have contractual regimes which pertains to the current Production Sharing Agreement (PSA) as signed with ExxonMobil.
The Chartered Accountant noted that petroleum taxation is the universal instrument through which governments seek to determine the crucial balance between the financial interests of the oil companies and the owners of the resource. It is a decisive factor in the oil and gas investment decision making process and it ultimately has material impact on production. Statia said that the design of fiscal regimes is critical in shaping the perception of competitiveness within the industry.
The Commissioner General asserted that the details of what fiscal tools are used and how they are applied to a particular oil and gas project are part of a country’s legal framework, which includes the laws, regulations, specific sector rules and contracts.
He asserted that there are many considerations a country contemplates in determining which fiscal tools to use and how to use them. While the government may have preferences, he opined that it must also respond to the needs of the companies if the state wants to attract and sustain foreign direct investments.
The GRA Commissioner General said, “The uniqueness of petroleum taxation, when compared to the taxation of other goods and services, lies in the industry’s special characteristic. He said that its contribution to national economies, the high operating and development costs, high uncertainty in exploration activities, the volatility of oil prices, the inability of government to fund its own exploration, the political and economic climate, and hostile neighbouring countries who harbour territorial claims which allow for increased risk, are all factors that warrant the demand for a higher rate of return by investors.”
Under a PSA or contractual term agreement, Statia said that the oil company is appointed by the government as a contractor, with the government retaining ownership of the natural resource. He noted that the parties agree that the contractor will meet the exploration and development costs in return for a share or a fee for this service, if production is successful.
The Commissioner General explained that the contractor has no right to payment in the event that discovery, appraisal or development does not occur. However, if there is a discovery, the contractor is allowed to recover the costs it has incurred.
Statia noted that this is known as Cost Recovery or Cost Oil. In respect to the accounting for exploratory costs, Statia said that successful drilling costs are usually considered to be a part of the cost of oil and gas reserves, while unsuccessful exploratory costs are usually written off.
The Chartered Accountant said that development costs, on the other hand, is considered to building a producing system of wells and related equipment and facilities, hence they are capitalized as part of the cost of the oil and gas. The Commissioner General said that this certainly would have been the thinking behind ExxonMobil’s pre-contract costs of US$460.2M, which represents exploratory costs as stated in Annex C, Section 3(K) of the contract it has with Guyana.
Additionally, the Commissioner General said that some countries may elect to ring fence their oil and gas activities, while others ring fence individual projects or wells. Ring fencing imposes a limitation on deduction for tax purposes across different activities, or projects undertaken, and prevents leakage since only losses incurred within the ring fence are allowed as a deduction from the ring fence profits.
The absence of ring fencing can postpone government receipts or revenues. In this regard, Statia explained to the Guyana Inc. Magazine that the contractor can deduct exploration and development costs from new projects or even dry wells (unsuccessful drilling efforts) against the income of projects already generating income. Also, during the maturity phase, the absence of ring fencing may discriminate against new entrants who may have no income against which they can deduct these expenditures.
Statia told the Guyana Inc. Magazine that because of the special characteristics that pertain to the industry, ring fencing of activities are sometimes employed, as was the case in the United Kingdom.
That being said, Section 51 of Guyana’s Petroleum (Exploration and Production) Act 1986, provides that the Minister responsible for Finance has the option to direct that any or all of the following Acts shall not apply to or in relation to the holder of a Petroleum License who has entered into a Production Sharing Agreement with the Government of Guyana:
– The Income Tax Act;
– The Income Tax (In Aid of Industry) Act;
– The Corporation Tax Act; and
– The Property Tax Act
This being the case, the tax chief said that Article 15: Taxation and Royalty, Article 23: Accounting and Audits; and Annex C at first glance, seem to outline the taxation regime that governs the current ExxonMobil Agreement.
However, other articles that are of relevance to the taxation regime include:
Article 7 – Annual Work Program and Budget,
Article 10 – Annual License Rental Charge,
Article 11 – Cost Recovery and Production Sharing,
Article 12 – Associated and Non-associated Gas,
Article 13 – Valuation of Crude Oil and Gas,
Article 14 – Disposal of Production,
Article 21 – Import Duties,
Article 27 – Applicable Law,
Article 32 – Stability of the Agreement, and
Article 33 –The Signature Bonus
Additionally, the Chartered Accountant noted that Annex D speaks of the Pre-approved and certified petroleum operation items.
He said, “As you are aware, Guyana will get both a share of production in the form of profit oil, as well as a fixed rate of two percent Royalty on Production Petroleum. Hence, Guyana has a hybrid agreement, in that, the agreement has both concessionary and contractual terms. Cost (cost oil), will be recovered from the value of Production to the extent of 75%, with all recoverable cost being carried forward indefinitely until fully recovered.”
“Let me hasten to add, however, that Guyana stands to gain considerably should oil prices increase or when the cost of production decreases. Apart from these production (royalty) and profit based instruments (share of profit oil), bonuses and annual rental payments are also features of the PSA, which are aimed at ensuring up-front revenue for the State while encouraging investors to explore and develop contract areas more rapidly.”
Additionally, the GRA Commissioner General said that the PSA only relates to the Contractor and the affiliated companies. Consequently, companies and sub-contractors, and their employees would be subjected to the various tax legislation under the Acts listed above, thereby allowing for PAYE deductions, withholding taxes and corporate and other applicable taxes. Despite the exemptions stated in Article 15.11 of the PSA with ExxonMobil, Statia asserted that this sizeable component will enhance revenue collection thereby allowing for Guyana’s take to be within 25% to 30% of the oil revenues. Further, with spin off industries based on downstream activities, Statia said that the impact on Guyana’s economy and its tax take will be phenomenal.
It should be noted, however, that the tax assessed by the GRA will be in accordance with the PSA, based on a Pay On Behalf (POB) arrangement and that the amount of such sum will be considered income tax of the contractor. What this means is that the government’s share of profit oil has the tax complement therein, hence the reason for the GRA to be extremely vigilant in the audit of the company at all levels of its operation and revenue from the sale of oil.
Statia, in agreement, said that all monies collected will first be placed in the Sovereign Wealth Fund which the Government has made moves to create before 2020.
Statia said that it is only through such vigilance that the true share of Profit Oil can be determined, and the tax base protected, so that the GRA can assure the Guyanese citizenry that they are receiving what is rightfully due to the country.
Statia also noted that cost oil is not the only determinant of profit oil. Revenue associated with the sale of the oil can also be subject to manipulation through intercompany and related party transactions.
He stressed that inflated costs will result in a decrease in available profit oil / petroleum, while deliberately depressed oil prices or non-arm’s length transactions in the sale of the oil can also lead to a reduced share to the Government and a larger share to the Contractor.
Additionally, the tax chief said that differing tax rates in jurisdictions where the contractor or its subsidiaries operate can create the incentive to shift profits out of Guyana to zero or low tax jurisdictions and shift costs into Guyana thereby distorting the tax base as well as profit base for profit oil split.
Statia said, “It is not unusual for multinationals to incur legitimate costs in the form of business overheads for services such as accounting, human resource, marketing, procurement, IT, etc. These costs, however, should be fair, reasonable and in line with arm’s length principles.”
“Excessive debt financing and recoverable interest should also be subjected to scrutiny and be subjected to limitations, especially when the loan transactions are between affiliated or associated companies. Thinly capitalized positions in the absence of rules aimed at limiting interest claims will be challenging and will require stringent policing efforts by the GRA.”
On the revenue side, Statia said that accurate reporting of the components of gross revenue; volume of production and sale price (value) of production would have to be safeguarded, with volume being less contentious as the methodologies for measurement of such are globally accepted.
The GRA Commissioner General said that the greater risk lies in accurately assessing the true market value of oil, especially when such a sale takes place between affiliated companies. When the sale is between unrelated third parties, market values are easier discerned through international benchmarks after considering crude quality, upliftment and production methods, etc.
Finally, Statia said that the ability to move revenues and shift costs between countries has become common for Multinational Corporations. He emphasized that complex corporate structures are adopted by many multinational companies, often using a conduit company / subsidiary, incorporated in a low tax or tax haven jurisdiction, as part of the chain of ownership leading to the main operator in the host country.
To this end, and realizing that GRA lacks the capacity to fully scrutinize the oil industry, Statia stressed that international assistance has been sought. He said that this continues to be the case as Guyana seeks to learn from the experiences of other countries and understand the financial, technical and socio-economic challenges that emanates from the oil industry.
He said that the GRA has reached out to the International Monetary Fund, the World Bank, the Commonwealth Secretariat, the UK, and Trinidad and Tobago, for training and secondment/attachments in this regard.
The Commissioner General said, “The Oil and Gas Unit has been established and is presently within the remit of the Large Taxpayers Unit and will be a separate Unit by 2020. Training for prospective members of this Unit is going on as we speak, and initial letters have been written to Contractors advising them of their obligations under the PSA. I can assure you that the officers of the GRA will be working to minimize the curses associated with our country’s oil find. Since the oil discovery, we at this institution have sought to acquire as much information and knowledge as possible on the socio-economic impact and technical requirement of oil production, and to equip ourselves with the tools necessary to ensure that our country’s share of Profit Oil is maximized.”
“At the national level, Guyanese are optimistic that the oil find will improve their quality of life. However, they are also cautiously optimistic being cognizant of the many countries that were affected negatively by oil wealth, with increasing political instability, environmental degradation, and increasing inequality.”
“As Commissioner General of the GRA, I am au fait with the potential of lost Government revenue due to tax avoidance and evasion strategies by multinational companies. It is a widely accepted fact that the extractive sector is particularly vulnerable to such. Guyana is not alone in this regard, there are a common set of challenges that affect all countries and therefore the threats to Government revenue will have to be assessed on a sector specific basis.”
The Commissioner General of the GRA said that it is a challenge, though not insurmountable, to protect the tax base of most economic sectors, let alone the oil and gas sector.
He said, “Our country’s revenue, based on the PSA for the Stabroek Block, will be determined by four (4) main variables; the volume of production sold, the price at which this was sold and hence production value, the costs involved in production and hence eligible for cost recovery and taxation.”
Notwithstanding the various challenges and risks associated with first oil, which he outlined above, Statia said that GRA is building capacity to ensure a mantra he repeated to all taxpayers since assuming the post of Guyana’s Tax Chief, that is, that all taxpayers must pay their true and rightful taxes.
He noted that the contractors in the oil industry are no exception, and with the right tools and attitude, the officers at the GRA will ensure that this vital resource contributes its rightful share to the coffers of Guyana.
“After all, this is a national resource that belongs to all Guyanese.”