New developments in oil and gas tax
14 March 2014
Posted by: Author: Ben Strauss
Author: Ben Strauss (Cliff Dekker Hofmeyer)
Recently there have been some interesting developments with regard to taxation in the oil and gas sector, notably with regard to the disposal of fiscal stability rights and exploration rights.
Disposal of fiscal stability rights
In terms of s26 of the Income Tax Act, No 58 of 1962 (Act) the taxable income of an oil and gas company must be determined in accordance with the provisions of the Act, but subject to the provisions of the Tenth Schedule to the Act (Tenth Schedule).
In terms of paragraph 8 of the Tenth Schedule, the Minister of Finance may enter into a binding agreement (referred to as a 'fiscal stability agreement') with a company in respect of an oil and gas right held by it.
The purpose and the effect of such an agreement are to guarantee that the provisions of the Tenth Schedule (as at the date on which the agreement was concluded) will apply in respect of that right as long as the right is held by the taxpayer. Put differently, in terms of such an agreement, the Minister and the company agree that the fiscus will not change the tax rates or rules of the Tenth Schedule for the duration of the agreement. (There is a similar provision in the Mineral and Petroleum Resources Royalty Act, No 28 of 2008). Essentially, a fiscal stability agreement gives the company certainty as to how it will be taxed in future and 'pegs' the incidence of tax.
In terms of paragraph 8 of the Tenth Schedule, an oil and gas company may, if it disposes of an exploration right or a production right to another party, at the same time assign (transfer) all (and not some) of its rights under a fiscal stability agreement to the other party.
National Treasury has recognised that oil and gas companies enter into joint venture agreements in terms of which one party transfers only a part of its exploration right or production right to another party and, accordingly, may wish to assign only some (and not all) its rights under a fiscal stability agreement so that both parties are covered by the original fiscal stability agreement.
The 2014 Budget includes a proposal that part assignments of fiscal stability rights be allowed in future.
Disposal of exploration rights
On 3 March 2014, the South African Revenue Service (SARS) issued a Binding Private Ruling (BPR 162).
At issue was the capital gains tax (CGT) consequences on the sale of an oil and gas right and the timing of payment of value-added tax (VAT) in respect of the consideration accruing on the disposal of the exploration right.
The facts of the ruling were that the taxpayer owned an exploration right which it had acquired in terms of the Mineral and Petroleum Resources Development Act, No 28 of 2002. The exploration right constituted an 'oil and gas right', as defined in paragraph 1 of the Tenth Schedule. The taxpayer held the exploration right as a capital asset.
The taxpayer wished to develop the exploration right. To do so, it wished to conclude an agreement with another party. Under that agreement, the taxpayer would sell a participating interest in the exploration right to the other party.
In return for the participating interest in the exploration right, the other party undertook to pay certain agreed amounts to the taxpayer.
Put simply, paragraph 7 of the Tenth Schedule provides that if an oil and gas company disposes of an oil and gas right held as a capital right to another company, and if the parties so agree, the company disposing of the right will suffer no CGT; instead, the company acquiring the right 'takes over' the base cost of the right. In other words, there is a 'rollover' for CGT purposes.
In the ruling, SARS held that (despite the fact that the taxpayer was only selling a participating interest in the exploration right to the other party) the taxpayer would qualify for rollover relief, as referred to in paragraph 7(1) and (2) of the Tenth Schedule. SARS ruled further that a letter by the taxpayer submitted to SARS, stating that both parties are in agreement that the rollover provisions must apply, would constitute the taxpayer's election for rollover relief as required in paragraph 7 of the Tenth Schedule.
Accordingly SARS held that the rollover relief would apply and, that no capital gain will be realised and no amount of CGT will be payable by the taxpayer on the disposal of the interest in the exploration right.
As to VAT, SARS ruled that the disposal of the participating interest in the exploration right constituted a disposal of 'fixed property' as defined in s1(1) of the Value-Added Tax Act, No 89 of 1991 (VAT Act) as the exploration right is a real right in land. Accordingly, the time of supply in respect of that supply for VAT purposes had to be determined in accordance with s9(3)(d) of the VAT Act. That provision states that the time of supply of fixed property under a sale is deemed to take place on the earlier of:
1. the date of registration of transfer in a deeds registry (which did not apply in this case); or
2. the date that consideration is paid for the supply.
SARS accordingly ruled that the taxpayer was required to account for output tax when payment of any consideration for the participating right in the exploration right was made.
The article first appeared on cliffedekkerhofmeyr.com.