Waniss A. Otman(102) Department of Economics, University of Aberdeen Log in to become a member of Waniss A. Otman's Fan Club!
August 2006
Introduction
Under the various tax laws of HC, IOCs have had to pay income tax either as a flat corporate tax or through separate petroleum tax legislation. In general income tax is paid by IOCs at rates varying from 35% to 85%, depending on a variety if factors such as prospectivity, the types of petroleum agreements applied, production volume and suchlike. Payment of tax can also be effected directly to the Treasury, or under separate legislation, to the responsible state body such as the Energy Ministry or a National Oil Corporation. Since the Venezuela experience of the middle of last century, many oil producing countries adopted the 50-50 principle i.e. an income tax of 50% on profits was applied by the HC. This approach was thereafter pursued by other oil producers in the Middle East region, such as Saudi Arabia in 1950. Seven years later, a similar approach was taken by the Libyan government in the 1955 Petroleum Law No.25.
Development of the Libyan Taxation System
This situation in Libya remained unchanged until the 1960s when the formation of OPEC led to its influencing the fiscal systems of its member governments, which began to request changes in the classical concession system in order to improve state revenue. By the mid-1960s the OPEC Formula, as it became known, had a considerable impact on OPEC allowances and pricing issues. However, the tax rate still remained at around 50% in Libya until the early 1970s, when the posted price issue produced much tension between the IOCs and governments of oil producing countries, particularly after what was known as the September Settlement in 1970 between the Libyan Government and IOCs. This was followed by three major international agreements regarding posted price which strongly influenced contractual terms regarding taxes and royalty rates, namely the Caracas Agreement of December 1970, the Tehran Agreement of February 1971, and the Tripoli Agreement of March 1971, which led directly to the Libyan Law No.30 of 1971 which increased tax from 50% to 55%, the same level as other OPEC members at this period.
In addition, increases in oil prices during the first oil shock of 1973 also lead most oil producing countries to increase their taxes and royalty. In Libya ’s case income tax and royalty increased to levels of 65% and 16.67% respectively, although in other OPEC members it ranged between 30% and 85%. For example in the UAE, in the Abu Dhabi upstream tax regime, income tax is levied at different levels varying from 55% to 85%, depending on daily production.
But in other countries such as the UK a general income or corporate tax applies, which has varied from 52% in 1982-83, decreasing to 33% in 1986-87, and currently standing at 50% after the application of supplementary taxes in December, 2005, while in Malaysia corporate tax on petroleum based companies is currently 38%.
In a purely Libyan context, The Petroleum Law No.25 of April 1955 has been amended fourteen times since it was issued, and five of these amendments have dealt with financial issues. The current general taxation situation, under Petroleum Law No.25 as amended, is covered in Article No.14. “Taxation and Division of Profits" which states that:
“ The concession holder shall pay such income tax and other taxes and imposts as are payable under the Laws of Libya, but shall not be subject to any form of taxation whether Government or Municipal or other exaction of such nature as to render him liable to taxation or other dues not payable by persons in general operating in Libya other than fees, royalties and surface rents made payable under this Law":- provided however that:
(a) “ If in respect of any complete year from and after the effective date as hereinafter defined the total amount of the fees, rents and royalties except 16.67% of the value of crude oil exported as herein defined, payable under this law and income tax and other direct taxes for which a concession holder is liable in respect of his operations and income therefrom under all petroleum concessions held by him in Libya falls short of 65% of his profit as hereinafter defined for that complete year, the concession holder shall pay to the Ministry of Petroleum such sum by way of surtax as will make the total of his payments equal to 65% of the profits aforesaid".
However, these frequent changes in the Law coupled with the rapid increases in the Libyan government’s income, as well as the controversies surrounding the posted price issues, meant that the upward escalation of the combined royalty-tax system placed an enormous degree of risk and uncertainties on the IOCs, who perceived that their original objectives granted under the original concession terms could not now be secured.
In addition, one result of these increases in royalties and taxes not only in Libya but also in other oil producing countries, was that they led the IOCs to devise other types of petroleum agreements with HC governments, and such uncertainties surrounding the tax regimes was one of the key factors leading to the rapid expansion of the PSC in the early seventies. Basically under the PSC system the IOC (Second Party) is exempted from paying royalties and taxes, which will be paid on their behalf by the host government NOC (First Party), with its revenue secured for an agreed share of the actual oil production. This PSC arrangements, despite tough contractual terms involving a government take as high as 85% in the case in Libya under EPSA 1 in 1974, was still seen by the IOCs as providing security and guarantees against unilateral changes applied to contractual terms and affecting the posted price and other issues related to taxation hikes. From the Libyan government point of view, its share under the PSC system was also secured at the same amount, or greater, than in the concession system.
The terms of tax exemption implemented in Libya upstream sector, which began in 1974 during the first generation EPSA, continued to be a feature of the second EPSA generation of the 1980s. However, in the mid-1980s many home country governments of the IOCs adopted a policy that did not recognize this tax exemption and started imposing tax on the company revenue. This led the IOCs to request help from the government of host countries to resolve this situation, taking into account the large share of the production obtained by the government’s NOC, in return for dealing with the tax payments to the government. In this situation, the IOCs called for a certified approval document or certificate which confirmed that they had already paid tax on their profits in the producing country.
However, in a Libyan context the tax situation become even more complex, facing further legislative and practical obstacles. Firstly, the LNOC refused to pay any taxes to the Libyan Treasury claiming that the EPSAs provided exemption for both parties from paying taxes, therefore the LNOC was not obligated to pay any taxes on the realized income from these types of agreements. Secondly, since Petroleum Law No.25 covered all the petroleum activities in Libya, the LNOC pointed to Article 15 which stated that “ All fees, surface rents, royalties, and surtax imposed by the implementation of his Law and the income tax shall be paid to the Public Treasury through the Ministry of Petroleum", claiming that the Ministry of Petroleum was the only body authorized to issue certificate of approval (receipts) to substantiate tax payment by the IOCs, although according to the law a receipt issued by the LNOC for payment of taxes on behalf of the company was not legally valid.
On the other hand The Ministry of Petroleum refused to issue any receipt for the payments of taxes if this was not done actually by the LNOC or the IOCs directly to the Ministry, insisting that such a receipt given by the Ministry should specify in detail the taxable income after deducting all the charges and expenses, and stipulating the value the of tax requiring payment.
These internal conflicts concerning the the tax system within the Libyan petroleum industry led to the collapse of the royalty and tax systems in early 1980s, with all the IOCs in the Libyan upstream oil sector ceasing operations. This happened largely because of the very high posted prices, significantly higher than actual realized prices, determined by the Minister of Energy, on which taxes and royalty were based. This in turn meant that many IOCs were in fact losing money – in essence, the more oil they produced, the more money they lost. In 1982, certain IOCs such as Wintershall and the Oasis Group were able to resolve this situation by obtaining agreement from the Libyan government to transfer their concession arrangements to fixed Net Profit Agreements. But clearly the damage had been done, and for many years subsequently such risks and uncertainties remained as major features of the IOCs perceptions of investment in Libya .
By 1986 the situation was effectively resolved by external events, in particular the commencement of the US sanctions against Libya in 1986, quickly followed by the departure of the US IOCs in the same year. The Libyan General People Committee (Cabinet) then in the same year passed Resolution No.158, as well as the General People’s Congress Resolution No.5 of 1986, which effectively eliminated the Petroleum Ministry and transferred its duties to the Cabinet, the Treasury Ministry, and the LNOC. Resolution No.158 clearly stated in Articles 2 and 9 that the LNOC Management Committee was to take over all responsibilities granted to the Minister of Petroleum in previous laws and regulations.
However, after the lifting of the sanctions in 2004, the Libyan energy sector entered a new phase, on account of the large wave of foreign investment targeting this sector. This also necessitated its upgrading by the Libyan Government, since it had become seriously rundown and impaired by the sanctions. This led to the re-establishment of the Libyan Energy Ministry, by the general People’s Congress Resolution No.2 of 2004 and Decision No.73 of the General People’s Committee of the same year, covering the Organization of the Administrative System of the General People’s Committee for Energy (Ministry), at the same time instituting new Ministry rules and regulations, with bodies such as the Libyan National Oil Corporation, the General Company for Electricity, and the Renewable Energies Project falling under its jurisdiction.
These significant changes at the top, however, appear to raise again the thorny issues discussed earlier regarding documentation for tax certificate payments. For example when EPSA IV was released it clearly stated in Article 19 that “ Second Party shall be subject to royalty and corporate income tax imposed by the Petroleum Law under this Agreement". It Also stated that “First Party agrees to meet and discharge any royalty and corporate income tax obligations relating to Second Party’s share of production as imposed by the Petroleum Law. " and
“ Second Party shall prepare the corporate income tax declaration as required by the Petroleum Law and submit same to the First Party for review and audit one month prior to the due date for submitting the declaration to the relevant tax authority. First Party shall notify Second Party of any comments thereon, in which event Second Party shall prepare a revised corporate income tax declaration incorporating such comments and submit same to First Party prior to the due date mentioned above. First Party shall process the corporate income tax declaration and obtain a tax certificate from the relevant tax authority in the name of Second Party, substantially in the form attached hereof as Exhibit F. such certificate shall promptly be delivered to Second Party"
Additionally the same Article stated how the tax was to be calculated:
“ For the purpose of corporate income tax and royalty calculations, the official selling price of GSPLAJ shall be used for calculating the revenue derived from disposal of Crude Oil, and the actual selling price according to the gas sales agreement(s) shall be used for calculating the revenue derived from disposal of Liquid Hydrocarbon by-Products, the prices referred to in Article 12.3.3 shall be used"
However this situation appears to the writer to reflect a fundamental flaw in the current drafting of the EPSA IV agreement, because the LNOC has a dual role of both assessing and approving the tax calculations as determined by the second party, and then paying the tax on its behalf – a very unsatisfactory situation. This is further complicated by the fact that the receipt for tax payments, (Exhibit 1 below), is clearly to be issued by the Taxation Authority. However, this would appear, again to be flawed, since the taxation authority appears to be acting simply as a rubber stamp for tax calculations reviewed and accepted by the LNOC – again surely a highly unsatisfactory situation. In this connection it is worthy of notice, however, that EPSA IV was drafted by LNOC in the three years prior to the reinstatement of the Libyan Ministry of Energy. Again it is instructive to note that while the new Energy Ministry was established in April, 2004, the first EPSA IV round was announced on September, 2004, a gap of only 4 months, which, it would appear, gave the new Ministry insufficient time to review its contents.
Exhibit 1:
Receipt of Tax Payments
“ The understanding representing (relevant tax authority) certifies that the corporate income tax and royalty due on ……. X Company …….. under the Exploration Production Sharing Agreement dated …… /……./….. has been paid by the National Oil Corporation to the Public Treasury in accordance with the Petroleum Law No.25 of 1955 as amended which amount to (………..) L.D. as royalty and (………) L.D. as corporate income tax for the paid from 01/01…. to 31/12/……. . "
Despite or perhaps because of the above, it is believed by the author that the new Libyan Petroleum Law which still being drafted by the Libyan policy makers, represents a significant opportunity for the Libyan government to resolve all the risks and uncertainties related to the tax position of the IOCs in Libya, and provide a rational treatment of complex and often confusing tax matters. Again, to bring Libya up to date with new global petroleum fiscal arrangements after its isolation during the sanction years, it absolutely imperative that the country seeks international consultancy and advice in dealing with these tax issues, as well as other significant fiscal matters and those relating, for example, to environmental protection and in-country procurement which are sadly lacking in the current EPSA IV agreement.
In actuality the new law has to find solutions to a variety of factors, for example the issue of posted prices on which tax and royalty calculations are based, and the continuance or otherwise of the Net Profit Agreement applied to Wintershall and Oasis Consortium if they continue to operate. There are also several other areas which require improvement in the taxation system under the new Petroleum Law, for example, reinvestment requirements or incentives for the contractor, requiring further exploration activities within the contract area. This situation is currently abused by IOCs operating in the Libyan sedimentary basins, for example Agip in its Abu Attifel in the Sirte Basin , where it holds very flexible contractual terms and productive fields, resulting in massive returns while its expenditure on exploration activities in these licenses is extremely limited. As well as this, the government needs to look at providing incentives through reductions in taxation to IOCs who decide to reinvest part of their profit in developing small and marginal fields. as well as encouraging them to enter into vertical reinvestment in the downstream sectors and gas and electricity facilities through similar tax breaks, the overall aim being, of course, to get the IOCs to spend more in the country and send home less of their profits.
Double Taxation Risks
As well as this, the Libyan authorities need to address issues related to the avoidance of double taxation and look seriously at expanding Libya ’s limited existing range of double taxation avoidance treaties, since this is essentially a significant area of uncertainty for IOCs, with the potential impacts of double taxation on their profitability perceived to be a significant risk.
As stated by a recognized authority on this issue, double taxation is a key concern for international companies operating in a foreign country, which may conceivably have to deal with the effects of both foreign taxes and their home country’s tax treatment of overseas income. Double taxation take place when countries have diverse classifications of taxable income / or profits. It can also arise when taxpayer or taxpaying entity resident (for tax purposes) in one country generates income in another country. It generally refers to situations where the same profit is taxed more than once in more than one country ( Johnston , 1994).
It is also important for the host country to realize, on account of the highly competitive nature of the global hydrocarbon industry, that double taxation is a very significant disincentive for investment in a given country. This is why, if there is no double taxation avoidance treaty in place, expenditure on foreign exploration will be extremely limited. This also explains the rationale of why, in today’s globalised and highly technical world, where foreign companies have virtually no geographical or physical limits as to investment destinations, it is important that host countries should realize that it is in their interest to structure their contracts and tax frameworks in such a way as to enable IOCs to claim as much double tax credits as possible in their home countries. This in fact will work in favor of the host country, which can then apply a higher host country tax burden on an IOC.
Final Remarks
This is why in a Libyan context, in order to encourage and expand the current upstream investment in the EPSA IV era, it is crucial for policymakers, especially as the country has been isolated for two decades from capital and cutting-edge technology, to strive to improve its fiscal attractiveness by embarking on expanding its currently very limited coverage of double taxation avoidance treaties. In doing so both perceived and potential tax-related risks would be lessened or eliminated.
Currently, for example, the country only has bilateral or multilateral tax treaties with a small number of countries. Libya’s first bilateral tax treaty was the Convention between the Government of Malta and the Government of the Libyan Arab Republic for the Avoidance of Double Taxation signed in 1972, followed later by similar agreements with Pakistan, India, and Egypt. Libya , as part of the Arab Maghreb Convention, has also had a multilateral double taxation avoidance convention with the other Maghreb countries of Algeria , Morocoo , Mauritania , and Tunisia , with effect from January 1994. By extending this network of double taxation treaties to include more countries that are home countries of existing or potential petroleum sector investors, certainty for foreign taxpayers could be significantly increased and risk correspondingly reduced. Again, whether the Libyan government attempts to standardize these double taxation avoidance agreements according to the UN or OECD models remains a moot point at this stage.
» left by Anonymous (308 days 2 hours ago.)
Does not discuss anything of relevance such as the actual tax system in place right now. Use of abbreviations without explaining them anywhere. Respond to this comment
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