IMPLICATIONS OF VAT BILL, 2014 ON OIL, GAS AND MINERALS [BAGAMOYO]

I MPL IC AT I ON S O F VAT B I L L , 2 0 1 4 O N O I L A N D G A S I N DUS TRY-T H E C AS E O F

TA N Z A N I A

Prof Handley Mpoki Mafwenga,[Ph.D, MSc, LLM, MBA, PGDTM, ADTM, LLB]

Macro-fiscal Policy, Advocacy and Tax Expert [URT]Ministry of Energy and Minerals [TMAA]

Editors Forum on the Extractive Industry In Tanzania[16th-19th July, 2014 in Bagamoyo]

1.0: EXTRACTIVE RESOURCES FOUND IN TANZANIA

Natural Gas 46.5

Trillion Cubic Feet

Oil60 Million Cubic Ft

Coal >1.5 Billion Tons

UraniumMkuju

Project: 137.3

Million LbsNamtumbo

- 35.9 Million Lbs Tunduru -

101.4 Million Lbs

♦ MANYONI PROJECT: 19 Million Lbs (57 M Tonnes)

Iron Ore103

million Tons

Gold 45 Million Ounces

Nickel209

million Tons

Tanzanite &Other Colored

Gemstones12.6 million

Tons[Tanzanite]+51

MillionCarats

[Diamonds]

2.0: OIL AND GAS OPERATIONS AND FISCAL REGIMES 2.1: LEGAL FRAMEWORK OF OIL AND GAS SECTOR

Upstream legislations;National Energy Policy 2003Petroleum (Exploration and Production) Act, 1980The Model Production Sharing Agreement, 2008(MPSA) between the Government, TPDC and the Oil Company.

Downstream legislationsNatural Gas Policy, 2013.Natural Gas Act (in the making )National Gas Utilization Master Plan

Crosscutting Legislations Occupational Safety and Health Act, 2003Environmental Management Act, 2004Tax Legislations Public-Private-Partnership Act, 2010

Source: Ministry of Energy and Minerals

Mkuranga 2007 (0.2 TCF)

Kiliwani 2008 (0.07 TCF)Songo Songo [1974 (2.5 TCF)Commercial operation, June2000 and Commercial production, July, 2004]Mnazi Bay 1982 (5 TCF)[Located onshore at the Msimbati Peninsula, Discovered in 1982]Ntorya 2012 (0.178 TCF)

2.2: OIL AND GAS DISCOVERIES

TOTAL GIIP (December 2013): 46.5TCF[38.5+8}

Deep Sea (2010-12) : 38.5 TCF

Total GIIP onshore = 8 TCF [0.2+0.07+2.5+5+0.178]


05/01/2023

LAKE TANGANYIKA NORTH

• The block is bordering DRC

• Lake Tanganyika World's longest lake: 650 km World’s second deepest lake: 1,500 m Average width: 50 km

• Covered by sparse 2D seismic data which were collected in the 1980s during the African Lakes’ Drilling Project.

• The data and report are available at TPDC.


05/01/2023

The 4th Tanzania Deep Offshore Licensing Round 2013

Launching date: 25th October 2013Mwl. Nyerere Conference Hall, Dar es Salaam – Tanzania

Number of Blocks to be offered: Seven (7) Deep Sea Blocks and L. Tanganyika North

♠ Blk 4/2A, ♠ Blk 4/3A, ♠ Blk 4/3B, ♠ Blk 4/4A, ♠ Blk4 /4B, ♠ Blk 4/5A, ♠ Blk 4/5B

2.3: OIL AND GAS DISCOVERIESOPEN ACREAGES FOR FUTURE LICENSING ROUND

05/01/2023

FUTURE BIDDING ROUNDS

Onshore:

Ruvuma

Mandawa Block

Kisangire Block

Selous Block


1952 - 1962 1963 - 1970 1971 - 1981 1982 - 1992 1993 - 2003 2004 - 2012 2013 - 2014 TOTAL0

10

20

30

40

50

60

70

80

40

10

17

3

32

10

76WELLS DRILLED from 1952 to APRIL, 2014

NO. OF WELLS

YEARS OF DRILLING REALIZATION

NU

MBE

R O

F W

ELLS

2.3: OIL AND GAS DISCOVERIES[CURRENT EXPLORATION ACTIVITIES]

PSAs signed 25

Onshore Licenses 17

Offshore Licenses 8

Operating Companies

17

Development Licenses

3

05/01/2023

2.4: UTILIZATION OF THE NATURAL GAS AS TAXABLE BASE IN ABSENCE OF VAT

EXEMPTIONS Power generation: 3,000

MW LNG (Onshore) Smelting plants Cement industries Other industries Household (Homes) Motor vehicles (CNG) Fertilizer production Methanol plants Plastics industries Other Petrochemical

Industries

2.5: HISTORICAL PERSPECTIVE OF TAX INCENTIVES REGIMES IN OIL AND GAS SECTOR

Tanzania does not have a specific tax regime for oil and gas, but uses existing tax laws to tax the industry operators amid a number of challenges. Although Tanzania has had modest hydrocarbon production since 2004, the tax framework of law and practice is not well developed. There are no specific rules in the VAT Act, Cap 148 and Income Tax Act Cap 332 to deal with upstream projects so there is nothing to cover situations like farm-in agreements, development carries, or other sorts of M&A activities.Tanzanian PSAs are not Principal Tax Legislations hence, the TRA may not rely upon because they are overriding domestic tax legislation unless they have been “legalized” by way of a GNs. The government has so far been reluctant to provide such a formalization of its contractual obligations and this is becoming a more and more pressing issue as projects move towards development.


In addition to general taxes there are a number of levies which are specific to PSAs. Annual charges are levied based on the area covered by the license. Once production commences royalty is due in cash or in kind. This is a liability of TPDC as formal holder of the license and the liability is discharged before the calculation of production sharing. The rate of royalty for deep water is 5% under the 2004 Model PSA.The 2008 Model PSA also provides for an additional profits tax („APT‟). This is a contractual obligation, and is not covered by tax legislation. The 2004 Model PSA does not provide this though we are aware that some older PSAs also include it. The APT is based on the project's rate of return.


Under the VAT Act, Cap 148, the First Schedule is for Export goods which stipulates that,

“Exportation of goods and services from the United Republic of Tanzania provided evidence of exportation is produced to the satisfaction of the Commissioner.”

The Evidence for the Oil and Gas Export License has to be covered though this Law however, was in place before Oil and Gas had come up with the new Policy and expectations for export.

Under the Second Schedule of VAT Act Cap 148 the Petroleum Products like Aviation spirit, spirit type jet fuel and kerosene type Jet fuel (Jet A-1), LPG gas and LPG cylinders, Petrol (MSP and MSR), diesel (GO), kerosene (IK), heavy furnace oil (HFO), industrial diesel oil (IDO) and AVGAS were given exemption.


Third Schedule Under the VAT Act a special relief is available to companies in the exploration phase to eliminate VAT on procurement of goods and services. Though the precise cut-off point is unclear, this relief will not be available for development costs. This gives rise to the potential for significant Tanzanian input VAT to be incurred on services during the development and production phase. Even once sales begin to be made by a project most of these are likely to be exports and therefore zero rated, leaving companies with excess input VAT. Though most E&P companies that have made VAT repayment claims so far have been paid by the TRA after an audit, there is a high risk that the process will slow once the size of the claims increases.

Likewise, Oil and Gas companies were given Relief on Capital goods under Item 26 which says:

“The importation by or supply of capital goods to any person”.


The Third Schedule to the VAT Act Cap 148 gives Relief for the

“Importation by or supply to AES Tanzania Services Limited, Ocelot International Tanzania Ltd, Pan African Energy Tanzania Limited and Songas Limited of goods and services required for the Songo Songo project.”

The aim here has been to enhance productivity at Songo Songo project through costs reduction on importation of goods and services .The VAT Act does not specifically address activities under a JOA. This gives rise to uncertainty over how VAT applies, for example it is not clear whether a JV billing is a VATable transaction or whether the operator is entitled to recover all VAT on behalf of the JV. Many other areas of uncertainty are likely to emerge as development programmes move forward.


Once VAT refunds payment fully operational many issues go away; unfortunately, there was no budget for net VAT revenue except gross revenue and refunds; VAT refunds had not been made on a timely basis The current VAT exemptions on general business inputs such as fuels, commercial land sale and lease, IT equipment are problematic; which causes “cascading “of VAT that raise costs for midstream in investments.The VAT exemptions in PSAs had not been treated to be necessary taking into account that refund system had not been properly worked ; The VAT treatment of gas has not been effected at transfer points: upstream to midstream and downstream.

Registration Threshold [Turnover in the twelve months is above 40million or 10 million Shillings in a period of three consecutive months w.e.f July, 2004 [As per Regulation of the VAT Act, Cap 148 and Section 30 of the VAT Bill

Normally holders of Special Mining License and Mining License for the Gemstone and Cement Producing Companies

LARGE SCALE MINING[SML fee USD 5,000; ML fees USD2,000]

Normally holders of Mining License; They May keep records but not proper

MEDIUM SCALE MINING

[ML fees USD 2,000]

Normally holders of Small Mining License or artisanal miners; They Do not keep records

SMALL SCALE MINING

[Primary License TZS 50,000/=]

Commissioner

General of TRA

TRA

Compulsory VAT-registration by the Commissioner General under Section 35 of the VAT bill

Mining Industry

Prospecting and

Development Activities

are Tax Shelter

Ventures; metallic minerals; energy minerals;

gemstone excluding kimberlitic diamond; kimberlitic diamond ; industrial minerals;

or building materials.

Closure Operations as part of Mining

Operations [VAT Deregistration

under Non-Continuity of

Economic Activities/Business

3.0: MINING OPERATIONS, LICENSING AND VAT REGIME

3.1: MINE LIFE CYCLE AND VAT LIFE CYCLE Phases of Mining Operations

Source: Mafwenga H.M (2013)

3.2: HISTORICAL PERSPECTIVE OF TAX INCENTIVES REGIMES IN MINING

Under the VAT Act, Cap 148 tax incentives are categorized into three Schedules: First Schedule for Zero rated, Second Schedule for Exemptions and the Third Schedule for Special Relief;First Schedule is for Export goods which stipulates that;

“Exportation of goods and services from the United Republic of Tanzania provided evidence of exportation is produced to the satisfaction of the Commissioner.”

The Evidence for the Mineral exportation is Export License issued by the Mine Zonal Officer. This Law however, was in place before Oil and Gas had come up with the new Policy and expectations for export though could have been covered as well upon export.

Second Schedule covers all exempt supplies where mineral products had not been exempt.

3.2: HISTORICAL PERSPECTIVE OF TAX INCENTIVES REGIMES IN MINING CONT…..

Third Schedule gives relief to mining industry; under Item 8 which states that Special relief prevails for the;

“Importation by or supply to a registered licensed drilling, mining, exploration or prospecting company of equipment to be used exclusively for drilling, mining, exploration or prospecting activities”.The aim of the Finance Act, No 5 of 2011 has been to provide Relief to Mining companies on goods and services whether acquired outside URT or within the URT. This however, confiscated the rights to enjoy Relief for the Mining companies which have MDAs dealing with mining operations; on contrary mining companies which were not for exploration or prospecting had to pay VAT and claim for the refund. However, due to the Challenges in the lag-refund repayments which affect Cash flows on part of the mining companies , this methodology has not been preferred by the mining companies bearing in mind that the Government has not been able to pay interest by virtue of section No 28(5) of VAT Act, Cap 148.


The Finance Act, No 5 of 2011 ISSN 0856 - 033IX came up with the following narration under Para 8(2); “The importation by or supply to a registered and

licensed mining company which has a mining development agreement with the Government executed before 1st July, 2009.“In this case, Mining Companies holder of MDAs which signed MDAs before 1st July, 2009 were given Special Relief so as to respect terms and conditions pertaining to the Contracts; Other Companies have no such relief the aim being to reduce erosion of tax base resulting from the Special Relief on part of the Government.


Likewise, Mining companies as it is for the Oil and Gas companies were given Relief on Capital goods under Item 26 which says:

“The importation by or supply of capital goods to any person”.The Major Mining Companies are holder of MDAs hence were given this Relief similar to any other companies, they had also been able to get relief on the capital goods acquired or purchased from the domestic market contrary to the objective of the VAT Act, Cap 148.

4.0: IMPLICATIONS OF VAT ACT, 2014 [HEREINAFTER KNOWN AS VAT BILL, 2014] ON OIL GAS AND MINING COMPANIES As a General Rule! The VAT Bill, restrict exemptions that could occur outside the scope specified by the Law; this also prohibit promise, commitment or understanding given whether in writing or otherwise by any person or any Government entity to override such General rule. However, the Law has adopted the Exemption and Credit Methods that could be applicable under the Treaties upon approval by the Minister.

Implications: The Bill protects Sovereignty of Parliamentarians and protect the tax base; while on contrary does not preserve room for the flexibility and may distort economic choice to investors if Parliamentary Session is to be held after a longer period of time

4.0: IMPLICATIONS OF VAT ACT, 2014 [HEREINAFTER KNOWN AS VAT BILL, 2014] ON OIL GAS AND MINING COMPANIES

The VAT Bill has only one Schedule as compared to the VAT Act Cap 148; the Oil and Gas industry is covered under Part II Item 10 whereby the imports of goods are exempt on the following Conditions;

1.The import of goods must be made by the registered and licensed explorer or prospector of oil and gas;

2.The goods imported be exclusively in use of an oil or gas exploration or prospecting activities;

3.The goods imported must first be eligible for relief under Customs duties under East African Customs Management Act, 2004

Implications: 1) Goods imported by the Oil and Gas companies after the

commercial operation or production starts will not be exempt thereby adding costs on part of the companies especially for the goods which may not fall under deferment scheme thereby affecting cash flow on their part

2) The VAT net will be increased and the tax base will be broadened

4.0: IMPLICATIONS OF VAT ACT, 2014 [HEREINAFTER KNOWN AS VAT BILL, 2014] ON OIL GAS AND MINING COMPANIES CONT…..The First Schedule which dealt with Zero rating is to be eliminated instead the VAT Bill provides Zero rating in the Specific Provision i.e. Section 58 on the following conditions;

1. When goods have been exported outside URT shall not be imported into the URT by the supplier or installed or assembled;

2. When goods have not been entered for home consumption after being imported shall be deemed to be export and subject for zero rating;

3. When such sale of goods are supplied to tourist or visitor by a licensed duty free vendor shall be zero rated but only if they have not been re-imported.

Implications: 1) The Bill introduce the destination Principle while only exports

will be zero rated thereby enhancing the VAT Net and protect the erosion of the tax base and reduce scope of the input tax claim

2) However, companies that could deal with services associated to the export of goods and other related activities may add costs

4.0: IMPLICATIONS CONT…..

4.0: IMPLICATIONS CONT…..Distinct characteristics of each element of the value chain require different treatment to attract investments. in that regard VAT Bill under Section 14 stipulates for Single and Multiple supplies where a supply consists of more than one element, the following Criteria shall be taken into account when determining how the supply applies;

1.Every supply shall normally be regarded as district and independent

2.Supply that consists of single supply from an economic, commercial or technical points of view shall not be artificially split [e.g. Gas Cylinder and LPG]

3.Essential features of transactions should be ascertained in order to determine whether the customer is being supplied with several district principal supplies or with a single supply;

4.A supply shall be regarded as ancillary or incidental to a principal supply if it does not constitute for customers an aim in itself but is merely a means of better enjoying the Principal thing supplied.

4.0: IMPLICATIONS CONT….. What if Upstream, Midstream and Downstream projects offer

products that would be deemed to be Single Supplies but one element is exempt and the other zero rated? In the current VAT Act Cap 148 exempt supplies when exported were deemed to be exempt and zero rated were deemed to be zero rated; the exempt had no chance of attracting input tax; in the VAT bill where a supply is both exempt and zero rated the supply shall be zero rated; this means upon export when there is exempt and zero rating, the zero rating would prevail

Implications: 1) Under the VAT Bill, the taxable person will be able to

enjoy input tax claims which would enhance value chain and ensures predictability of cash flows

2) This would reduce the VAT net and tax base that would likely decrease the budget cake

4.0: IMPLICATIONS CONT….. What if One of the segment of Economic activity is

sold e.g. Songosongp Project opts to sale Downstream Segment or ABG opts to sale one of its Mine project?

Implications: 1) The VAT Bill broaden the tax base by introducing VAT

on partial sale of economic activity as going concern

4.0: IMPLICATIONS CONT…..Are Oil, Gas and Minerals Taxable Products? YES

Oil, Gas and Minerals are supply which are not exempt supply unless stipulated under specific provisions; and whenever, are made in Mainland Tanzania by Oil, Gas and Mining companies which are taxable persons when acquire supply for the furtherance of an economic activity carried out by them (Section 2) and when they are exported will be taxable at a zero rate no matter there are exempt supplies or not (Section 58)

Implications: 1) If they are not exported; companies will pay 18% of invoice

value of taxable supplies or taxable imports (Section 3) this will increase the VAT net and preserve for the predictable tax base, the tax burden will shift to the ultimate consumer of oil, Gas and minerals.

2) If exported; companies will reclaim all the input tax relating to the furtherance of the person’s economic activities (Section 71(1)(b)(c) this will enhance productivity, predictability in cash flows on the person’s economic activity as incentive and will reduce the VAT revenue net.

4.0: IMPLICATIONS CONT…..Are Petroleum Products taxable? NO

They are exempt under Para 15 of the Schedule Aviation Spirit 2710.12.30Spirit Type Jet Fuel 21710.12.40Kerosene Type Jet Fuel (JET A-1) 2710.19.21Petrol (MSP and MSR) 2710.12.20Diesel (GO)2710.19.31Kerosene (JK) 2710.19.22Bitumen 27.14LPG 2711.11.00

Implications : 1) They have no VAT element hence, enhance productivity, ensures

predictability of cash flows and increase economic efficiency to taxable persons

2) However, Would likely reduce the VAT net and reduce the tax base

4.0: IMPLICATIONS CONT…..Deferment of VAT on Capital Goods

The definition of Capital goods is based on the “Use Test Rule” in line with Section 11(10) of the VAT Bill; under the following conditions; a)The goods must be for use in the economic activity;

b)The Economic activity must be owned by the registered person;

c)The goods must have a useful economic life not less than one year and which are not consumables or raw materials or imported for the Principal purpose of resale on the ordinary course of carrying on person’s economic activity.

Implications: The mining companies typically export most, if not all of their outputs combined with their large investment needs may complicate deferment objective because they will be in a net-refund situations seeking to reclaim input tax

4.0: IMPLICATIONS CONT…..What about the Refund administration? The refund will be made when the output tax exceed input tax and when there is no set-off between output tax and input tax; the extent to which the balance will be carried forward for six month or more tax periods Implications 1)This enhance stability and predictability in the

cash flows for taxable persons as would serve as tax savings from the outset

2)However, the period of six months has been the practice under VAT Act, Cap 148, apart of having special account and the extent to which VAT refunds are not guided by the Appropriation Act, has remains to be a big challenge

Is 50% Rule a Solution? YESThe 50% Turnover Rule on zero-rated is adopted where 50% or more of the person’s turnover are zero rated there will be no carry-forward. This means turnover is not able to collect output tax e.g. the case of mining companies; or 50% input tax Rule is applicable on acquisition or imports that relate to making supplies that are or will be zero-rated; e.g. Input tax associated to the production of minerals (eg quarry operation on cement) if are 50% or more will be refunded without carried forward.

The application for the refund shall not be made more than 3 years after the end of the tax period to which the negative net amount relates . The decision shall be made by CG within 90days of its receipts. The refund application are not subject to audit and investigations so as to preserve room for the “Principle of Certainty” that taxpayers information will be trusted by the TRA

Implications: In the absence of effective tax administration would cause fictitious declaration; however, this gives taxable persons stable, predictable and effective planning of economic arrangement if the period of 90 days could be reduced to 30 days.

THANK YOU

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IMPLICATIONS OF VAT BILL, 2014 ON OIL, GAS AND MINERALS [BAGAMOYO]

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