Kenya needs new law for taxation of petroleum sector

In the just read Budget, Finance minister Njeru Githae indicated that in reforming the tax system to improve efficiency, the Government shall institutionalise a comprehensive framework to govern taxation of the potential vast minerals Kenya may be sitting on.

Oil and gas resources would require a solid taxation framework. The country should navigate this process in an all-inclusive manner and possibly enact a Petroleum Act to cover the oil and gas sector.

Tullow Oil’s recent announcement of a major breakthrough in its exploration activities in Turkana with a possibility of major oil reserves was greeted with measured excitement in view of experiences in other places.

Oil resources if well used can be a major source of export revenue, tax revenue and to a large extent employment. Collecting revenue from the oil and gas sector can be through securing a share of the economic rent through either profit or production-based instruments.

Production-based agreements, such as royalties ensure that the Government receives at least a minimum payment for its mineral resources.
Prospecting for oil requires huge investment and equipment and technology and thus proper tax incentives are needed to encourage further exploration, which ultimately will provide a lot of tax revenue.

As it stands, the government has not provided a sufficient taxation environment to spur investment in the oil and exploration sector.

Firstly, the incentives provided under the Kenyan Income Tax Act (ITA) are not adequate to encourage a potential investor. Primarily, the ITA does not comprehensively cover tax issues in this sector, perhaps a major consideration would be the enactment of a Petroleum Act to cater for this industry.

Secondly, the oil and gas sector involves the acquisition and transfer of rights and assets. This ultimately has capital gain tax implications especially when IOC’s transfer licences and rights having discovered oil.

A Capital Gain Tax is charged on the gains accrued on the transfer of an asset either through acquisition, sale or exchange.

Recently there was a tax dispute in Uganda between Heritage Oil and Gas and the Ugandan Revenue Authority after Heritage decided to settle for a quick profit by selling its stake in the exploration. To avoid such a scenario, Kenya may consider reintroducing capital gains tax which was abolished in 1985.

The Ninth Schedule of the Income Tax Act provides the following incentives, but they insufficient: duty-free importation of equipment by petroleum subcontractors, recovery of costs incurred in petroleum operations as cost oil, recovery of costs of abandonment, claim of capital allowance within five years from the date of production and claim of tax deductible expenses from the profit for the period. It also provides for duty-free importation of machinery and equipment for exploration.

Specifically, the Government should consider several initiatives to contribute to the sector’s growth.

For one, create a free trading zone for oil and gas companies. This is a practice that has been adopted in some countries to reduce licensing bureaucracy and increase efficiency in operations.

Nigeria has abolished Value Added Tax and withholding taxes for storage facilities and services within the oil and gas free trading zone.

Secondly, the Income Tax Act provides that tax losses can only be carried forward four years from the date the losses were incurred.

Given the huge capital outlay involved, it will be difficult to recoup the capital investment within four years as a tax deduction of expenditure will lead to the company making tax losses beyond five years. The Government should consider allowing an extended carry-forward of tax losses as a special incentive for explorers.

Australia allows oil and gas companies to carry forward tax losses indefinitely based on continuity of ownership guidelines.

Sharing agreements

Thirdly, the Government may consider introducing additional corporate tax deductions in form of capital allowances, tangible depreciating assets and qualifying expenditures. These will be added to the existing allowances under the Income Tax Act.

Fourthly, the Government should also consider incentives that encourage research and development in the form of deductions on R&D expenses, ultimately accruing tax savings for small Kenyan companies eyeing this industry.

Fifth, critically address production sharing agreements. Such a contract is a fiscal arrangement where a country’s government awards the execution of exploration and production activities to an oil company.

With a proper tax framework and mouth-watering incentives the oil and gas sector will be a major tax revenue contributor to the Treasury.

However this requires a balancing act where special emphasis is on the financial interest of the investors.

Mr Maina is a tax manager at PKF Taxation Services Limited;
e-mail: [email protected].