Taxation in the Upstream Oil and Gas Sector

Posted on September 14th, 2018

By Geoffrey Muchiri

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26th May 2012 is a date that will forever remain etched in the minds of Kenyans as it is the day when the announcement was made that vast quantities of oil had been discovered in Turkana County. Commercial viability of those discoveries had not been determined but from that date Kenya became a new petroleum province of great interest to all in the global oil and gas industry. It is in the context of this discovery that Kenya’s numerous oil blocks are seeing a renewed interest from International Oil Companies(IOC) (be they: small independents or the oil majors/seven sisters and their successors in title) or National Oil Companies from other countries.

The exploration and production of oil and gas is a very expensive capital intensive undertaking as the preliminary shooting of seismic and the drilling of exploratory wells in an oil block in accordance with the work programme agreed with any Government in any country may cost between US$1 million to over US$ 15 million and Kenya is no exception (this is coupled with the attendant risk that there is always a great possibility that the oil(if any that is found) may not be in commercial quantities). The development and production phase may involve the construction of the infrastructure necessary to transport the oil from the wellhead to the port of Mombasa or Lamu and may cost hundreds of millions of dollars.

For that reason any IOC that  seeks to sign a Production and Sharing Contract (PSC) with the Kenyan Government in respect of the available oil and gas blocks (be they onshore or offshore) would like to ascertain up front what taxes if any are applicable during the exploration phase as well as the production before the IOC can proceed to make any contractual commitment by signing and sealing the PSC. This accords with what Lord Mansfield stated in 1774, that in all mercantile transactions the great object should be certainty. This aphorism holds true to this day especially in the oil and gas sector.

The taxes applicable to the oil and gas company undertaking exploration and production of oil in Kenya are as follows:

  1. Corporation tax on the profits during the production phase (with an allowance being given for amongst others: production costs (recovered from the cost oil within a period of between 4 and 5 years), intangible drilling costs, payments to the government under the PSC, executive and general administrative expenditure incurred in Kenya ( as well as outside Kenya with special exception in the sense that those expenditures although incurred outside Kenya relate to Kenya), management fees, interest paid on loans(provided tax on the interest has been deducted and paid). The corporation tax rate is 37.5% for non-resident companies and 30% for resident companies.N/B: Since many IOCs which happen to be oil majors are vertically integrated there is a likelihood they may sell oil to their subsidiaries involved in marketing and for that reason there are rules that govern and ensure that such sales are done on an arms- length basis.
  2. A tax on any transfers of any interest in the property and/ or shares of an oil company was introduced in This attempts to cover: take-overs and farm-outs as well as outright sales of the whole interest. This tax was introduced as a result of a battle that the Kenyan Government lost when it tried to call for its share of taxes when an international take-over of a company had the effect of resulting in the acquisition of stakes in some oil blocks in Kenya.
  3. Government share of profit oil is also a tax from the IOC’s. The Government share of profit oil is calculated on a sliding scale with the government share increasing dependent on how many barrels of oil are produced from a particular oil block (akin to the sliding scale that applies to an individual person’s income in Kenya whereby the government take/tax increases with  each  increasing level of income). The Government share of profit oil is a negotiable variable and this is a factor which ought to be taken into consideration as one engages the Government in  negotiations leading up to the signing of a PSC.
  4. Windfall profits tax may be included in some concluded Production Sharing however, in light of the continued sharp price decline in the global oil prices. This might not be a very attractive tax model.

Ring-fencing is applicable to the upstream oil and gas sector in Kenya. This means that losses from one oil block cannot be used to reduce the taxable income in respect of another profitable oil block.

The Kenyan Government is currently at an advanced stage of concluding the preparation of new legislation that will govern the upstream oil and gas sector in Kenya.

Cindy Oraro

Posted on March 26th, 2018

Cindy Oraro 

Partner

 

T: +254 709 250 000/709 250 718

E: cindy@oraro.co.ke

 

 

A Partner at Oraro & Company Advocates’ commercial practice, Cindy specialises in energy, infrastructure, and projects. Over the last 9 years, she has advised local and international clients in various matters including energy, oil & gas, corporate restructuring, mergers & acquisitions and mining.

She has been involved in notable corporate & commercial transactions including advising on the government-to-government collaboration between the Government of Kenya and China National Petroleum Corporation on a proposed USD 1.8 billion project to develop up to 350 MW of geothermal power.

In 2014, she was awarded a Commonwealth Professional Fellowship at the law firm of Hogan Lovells LLP in London, where she practiced with its project finance team. She was further awarded a Power Africa Fellowship in 2019 at the law firm of Shearman & Sterling LLP in New York, where she practiced with its project development and project finance teams.

Cindy holds a Master of Laws in Commercial Law from the University of Bristol, a Bachelor of Laws from Durham University, United Kingdom and a Post-graduate Diploma from the Kenya School of Law.

"Cindy has a keen interest in energy, particularly geothermal, oil & gas and solar."
Experience
  • Part of a team that advised the Government of Kenya on the financial and operational restructuring of Kenya Airways (KQ) including converting USD 2.3 Billion into equity and the legal implications of relinquishing its security.
  • Part of the team advising one of Kenya’s largest publicly listed sugar manufacturing companies on the restructuring of its debt by both local and international lenders.
  • Part of a team that advised a consortium of special economic-zone operators in the manufacturing sector looking to establish a corporate presence in Kenya and advised on their regulatory compliance.
  • Advised on an energy project with design-build finance maintain and operate aspects where we acted for the owner of five (5) SPVS entitled to generating 40 MW of solar energy each in a transaction to sell the SPVs as well as all the rights and licenses required to generate such power, as well as transferring the land which is subject to the licenses.
  • Advised a client on the legal structure of its equipment leasing framework and reviewing its operating lease and instalment sale and full maintenance agreement.
  • Advised a multilateral development bank on the USD 30 million financing of a tertiary care multispecialty hospital.

About Us

Oraro & Company Advocates is a full-service market-leading African law firm established in 1977 with a strong focus on dispute resolution and corporate & commercial law. With a dedicated team of 10 partners, 4 senior associates, 10 associates, 1 lawyer and 36 support staff, the Firm has been consistently ranked by leading legal directories such as Chambers Global, IFLR 1000 and Legal 500 as a top-tier firm in Kenya.

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