Managing Tax Risks - Taxes Applicable to Oil and Gas Sector

In our last article we noted that although some countries have a special fiscal regime for taxing the extractive sector including oil and gas, Tanzania does not have a special tax regime for the sector.

Thus the existing tax laws available are also applied to the oil and gas sector with some few

modifications. We also indicated that there are various laws applicable to the gas and oil sector including the Petroleum Act, 2015, Constitution of the United Republic of Tanzania, EWURA Act of 2001, the Income Tax Act, Cap 332, VAT Act, 2014 etc.

We also noted that the taxes applicable to the oil and gas sector include the income tax which includes corporate income tax, withholding taxes and employment taxes.

Today's article is focusing on corporation income tax.

Corporation Income Tax

Income tax rate for resident and non-resident oil and gas companies is 30 per cent which is similar to companies in other sectors. Income tax for Corporations (Corporation tax) is a tax charged on the taxable incomes (profits) of entities including limited companies, clubs, societies, associations and other unincorporated bodies. Corporations in the oil and gas sector with perpetual tax loss for 3 consecutive years are taxed 0.3 per cent of annual turnover computed from the third year of perpetual tax loss

Depreciation Allowances

For oil and gas companies expenditures on plant and equipment are written off using the reducing balance method at depreciation rates of 37.5 per cent, 25 per cent or 12.5 per cent.

However, the capital expenditure incurred for petroleum exploration and production are put under class four and enjoys a straight line depreciation rate of 20 per cent. This covers natural resources exploration and production rights and assets used in prospecting, exploration and development expenditure.

Ring Fencing of Recoverable Costs

Similar to income tax assessment for mining activities which is done separately for every mine i.e. ring fencing, under petroleum operations recoverable costs of exploration and development licence are ring fenced.

Section 118(1) of the Petroleum Act, 2015 stipulates that "the licence holder and contractor holding an exploration licence or more than one developing licence within a contract area shall ring fence recoverable contract expenses". Thus entities cannot transfer recoverable costs of exploration and development from one contract area to another and enjoy some tax advantages including the ability to use the expenses from new development area to reduce tax liability in another profitable location. This change was incorporated in the Petroleum Act, 2015.

Thin Capitalization Rule

A company is said to be thinly capitalized if a big chunk of its capital structure is financed by debt as compared to equity. Companies in the gas and oil sector just as in other sectors can use debt as a means to finance their businesses and use interest charged on the debts to reduce their tax liability.

In Tanzania interest deduction on debt finance is limited to the debt to equity ratio of 70:30 to discourage companies from excessive use of debt to finance their operations with the sole objective of reducing tax liability.

However, section 117(5) of the Petroleum Act, 2015 empowers the Petroleum Upstream Regulatory Authority (PURA) to give approval on the percentage of loan allowed out of total capital.

The unapproved loan amount shall not be allowable for tax deduction purposes. The interest rate for these loans has also been restricted to available lowest market interest rate.