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.  

The changes introduced include ring fencing of mineral and petroleum operations; granting of depreciation allowances; realisation (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 the treatment of unrelieved losses as well as provisions for rehabilitation and decommissioning expenditure. Today we look at realisation (disposal) of mineral and petroleum rights.

Realisation (disposal) of mineral and petroleum rights

Disposal (farm out arrangement) of mineral and petroleum rights before commencement of production shall now be treated as an investment asset.Effectively, these are no longer business assets and are now treated as investment assets separate from other interest in the land making up the license area and separate from any other asset used in mining or petroleum operations. 

Collection of tax by a way of single instalment tax

Tax on the above realisation shall be collected through single installment as per the requirements of section 90(1) of the Income Tax Act, 2004  which requires that “Where aperson (an “instalment payer”) derives a gain in conducting an investmentfrom the realisation of an interest in land or buildings situated in theUnited Republic, shares or securities held in resident entity theperson shall pay income tax by way of single instalment equal to –(a) in the case of a resident person, ten percent of the gain; or(b) in the case of a non-resident person, 20 per cent of the gain.

Future payments

Further, realisation shall include any form of payment or benefit to be derived in the future from the realisation of an asset at market value at the time of the realisation or as prescribed by regulations. The present value of a reasonable estimate of the amount of the future payment shall be used to determine the market value of an obligation to pay a future amount. 

Implication to businesses 

Classification of farm out arrangements as investment assets implies that income from disposal of mineral and petroleum rights cannot be offset by expenditure incurred on the project. Effectively, this also denies the purchaser of the license the ability to deduct expenditure used under the license up to when the license is disposed. 

This will lead to more corporate tax to purchasers of such licence. The current arrangement whereby the license and the project are treated as one and the same operation provides incentives for small investors who might not have the financial muscles to proceed to exploration thus preferring farming out/disposal. Also taxing of future payments may also discourage investors and thus slow down activities in the mining and petroleum sector.

Mr Makundi is a Partner with Auditax International