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News Analysis: Uganda’s Heritage Oil Tax Dispute Getting Dirty? Print E-mail
Wednesday, 01 September 2010
The stand off over the payment of capital gains tax on the sale of Heritage Oil’s assets to Tullow Oil has taken a new twist when the Government of Uganda withdrew Tullow’s exploration rights for the Kingfisher area in block 3A.

When Heritage Oil decided to exit Uganda, there was lots of money involved: For the 50% of the two oil blocks they operated together with Tullow Oil, Heritage agreed on a sales price of USD1.45bn. Uganda’s government thought they’d very much like to retain some of this, and should be legally entitled to it as well: For several months, the oil company has been locked into a dispute with the Ugandan government over the payment of capital gains tax on this transaction.  

To Pay or Not to Pay?

Heritage argue that they should not have to pay capital gains tax as previous acquisitions involving assets in Uganda had been untaxed, and reportedly the production sharing agreement (PSA) does not contain a clause stipulating that this tax would fall due in the event of a sale. The Government of Uganda (GoU), however, maintained that like any asset sale, this one would incur capital gains tax. Heritage eventually eventually took a slightly more conciliatory stance, and it was left to Tullow to help things along: Tullow have paid USD1.05bn directly to Heritage,USD121m to the Uganda Revenue Authority (URA), and have USD283m into an escrow account in the UK pending the outcome of arbitration hearings in London that Heritage had proposed.  

Comenting on the jurisdiction of the agreement, Energy Minister Hillary Onek stated in the media: “There is a whole page about tax in the Production Sharing Agreements, which puts tax disputes under Ugandan law and only other issues are subject to arbitration in London. There is also provision for a tax tribunal under Ugandan law to which Heritage should take their dispute. The remaining 70% of the dispute sum should have been deposited in a Ugandan bank, not Standard Charted London.”

Legal Transition?

Whether Onek is right or not is difficult to verify for anyone but the parties involved in this transaction: Part of the problem is that Uganda’s government has so far steadfastly refused to make the PSAs public. Underlying the dispute is also be the fact that the nascent oil sector is in transition from exploration to production, and so the legal and regulatory framework for the oil sector is still evolving.  

The transitional state also means that Uganda’s institutional capacity to manage the oil sector is still developing: GoU is thought to have resisted Heritage’s offer to go into arbitration in the UK over concerns that the country did not have strong enough lawyer capacities to defend their position.
 
Recently, the Ugandan government has proposed changes to its income tax law through the 2010 Income Tax Amendment Bill. Oil production is expected to start in the fourth quarter of 2011, and the legislation is intended to improve the legal framework to tax oil. For this, the bill also proposed implementing new reporting requirements, with some of those reports to be filed quarterly, and penalties for defaults ranging from USD50,000 to USD500,000. In setting such a tight time frame, the GoU betrays a level of skittishness, indicating that the legal dispute over the capital gains tax has created concerns of missing out official public revenues from the oil sector.
 
GoU’s latest move to collect the capital gains tax was not entirely orthodox: Onek announced that Tullow Oil had missed the February deadline to reapply for the exploration license for the Kingfisher (Kajuburizi) Discovery Area, and that it now ceased to form part of block 3A. This is not really about Kingfisher – Tullow already warned that an extension of the license was not expected until the tax dispute was resolved.  

Fingers in Cookie Jar


In the background to this dispute over official public revenues ran another wrangles over rather more unofficial and private revenues, prompting president Yoweri Museveni to put his foot down: In a letter copied to the vice president, the prime minister, the minister of finance and the minister in charge of presidency, he ordered Minister for Energy, Hilary Onek, to stop endorsing deals with oil firms, and that no deal would go ahead without his own explicit approval. Museveni cited ‘excitement and stampede’ around the oil deals as the reason for his intervention. The background to this is clear: Onek was one of the officials who continued to back Italian ENI’s bid to acquire the Heritage assets despite the fact that Tullow had pre-emptive rights, and intended to exercise those rights. Now that it is clear that Uganda has commercially viable reserves and will be an oil producer, there is a bit of a feeding frenzy – thus the presidential intervention to put a halt on irregular deal on the side.  

In principle, the president’s letter should create a bit more security for companies intending to follow due process, and will have come as a relief for Tullow – at least in the short term. Ironically, of course, the president is notorious for circumventing official procedures and officials himself, and not necessarily to transparency-enhancing effect: Remember, for example with his decision to abort the ongoing privatisation process of the Dairy Corporation with the order that the company should be sold for a nominal dollar to a Thai investor who was later exposed by local media as financially too strained to take on this investment.  

Perspectives: Governance Concerns


Even though Tullow’s agreement with Heritage was unambiguous, ENI made several attempts at acquiring Heritage’s share in both blocks. The president’s intervention may have resolved the case in Tullow’s favour, but it also enhanced the perception that the oil sector remains the fiefdom of the president and his entourage – a factor that will play into Uganda’s political risk development as the impending oil revenues up the stakes in the political contest. Museveni has just officially confirmed that he will run again in the next elections – not that anyone had doubted this – and shows little signs of planning for a successor, either to hand over to voluntarily, or to make provisions for an emergency.

Parallel to asserting their right to pre-empt any sale of Heritage’s assets, Tullow Oil have continued the process of selecting a larger partner with both financial muscle and oil production experience. The tax dispute meant that the Ugandan government only gave conditional authorisation to the farm in of CNOOC and Total, which has now held up the development of the oil fields for several months. Tullow indicate in their half-year results that they anticipate a slowdown in activities in Uganda in the short term before proceeding with CNOOC and Total as planned to submit the final development plan to the Ugandan government in the first half of 2011.  

However, the stand off over the capital gains tax, including the indirect pressure via the Kingfisher license, indicates that the GoU resorts to bullying tactics in matters where the legal and regulatory situation should be far more transparent, and puts financial and other pressure on one of its key oil sector investors even though the tax dispute should be resolved between GoU and Heritage. This overall situation is not helped by the fact that the president now deems it necessary to authorize every deal personally – his decision essentially drew attention to the fact that there are, as yet, no competent and transparent institutions to manage the sector.



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