New tax regime for extractive industry

The Finance Act, 2016 has introduced a new income tax regime for the extractive industry. The Income Tax has been amended to incorporate two new divisions for mining and petroleum respectively. 

Tax regimes for the extractive industry are different from the regimes of other sectors partly because of the uniqueness of the sector.

Some of the unique features of the sector include long period of exploration, uncertainty regarding production outcomes, high sunk costs, unpredictability of future revenues due to fluctuations of oil/gas and mineral prices, a long production period before reaching break-even point, substantial rehabilitation and decommissioning expenditure and exhaustibility of the resources etc. 

The changes introduced include ring fencing of mineral and petroleum operations; granting of depreciation allowances; realization (disposal) of mineral and petroleum rights; treatment of unrelieved tax losses; treatment of joint mineral and petroleum rights; treatment of bonus payments, provisions for rehabilitation and decommissioning expenditure etc. Last week we looked at ring fencing of mineral and petroleum operations and the granting of depreciation allowance. Today we look at treatment of unrelieved losses as well as rehabilitation and decommissioning expenditure.

Loss relief

Previous years unrelieved losses of an operation may reduce income of the same operation in the current year up to only 30 per cent of the current year income. The other losses will be carried forward.Ring fencing on losses for petroleum applies to upstream, midstream and downstream activities while for mining it applies to mineral operations, processing, smelting and refining activities.The perpetual loss corporation rules (alternative minimum tax) are also not applicable.Effectively this provision implies that the Government wants to ensure that entities in the extractive industry with a taxable profit and with no carried forward losses pays income tax of at least 30 per cent. Entities in the extractive industry will be affected by this limitation in terms of project cash flows as the timing of tax payments is fast tracked.

Rehabilitation and decommissioning expenditure 

Rehabilitation and decommissioning expenditure are exempt from income tax (for upstream, midstream and downstream activities) only when payments are made to a rehabilitation or decommissioning fund. Rehabilitation expenditure with respect to a mineral operation, processing, smelting or refining minerals covers expenditure incurred on abandonment activities including reclamation, rehabilitation, restoration and closure of an operation as required by law, mineral right or development agreement.  Decommissioning expenditure applies to petroleum operations and refers to expenditure incurred on removal or disposal of structures, facilities and installations operations in an area, cleaning of the area, plugging and secure of wells, restoration of land, safety clearance related to abandonment or cessation of petroleum operations. Decommissioning fund is a fund established under the Petroleum Act, 2015 for activities authorized by the decommissioning plan.  

The requirement for payments for expenditure to be paid to a fund for a relief to be provided will to some extent limit the ability of companies to claim the relief for tax purposes as some companies may not be ready to tie up a significant amount of fund at initial stages of operations.

Mr Makundi is a partner with Auditax International