Buying overseas oil and gas assets? Local taxes apply

For an import-dependent country like India, acquiring energy assets abroad is a significant step towards not only achieving energy security but also gaining a slice of the global energy business pie. With this objective, Indian oil and gas companies are aggressively scouting for opportunities in oil and gas assets overseas.

However, there are several tax and regulatory challenges involved, as the framework for oil and gas operations is still at a developmental stage in many countries.

Differential taxation

As natural resources are considered sovereign property, it is not uncommon to find a differential tax regime for oil and gas operations. The tax rate and computation of tax liabilities are structured by some countries in a manner that maximises government revenues. In some West Asian and African countries, there is mandatory participation of the national oil company (NOC), and the tax collection mechanism is so designed that the NOC discharges the tax liability for the foreign oil company. This arrangement may pose difficulties in getting tax credits in the home country.

business presence

Depending on the nature of acquisition — whether it is an asset-level acquisition or corporate-level acquisition — it is critical to evaluate the form of business presence to undertake oil and gas activities. When acquiring a direct interest in the assets, and assuming the asset is at an exploration stage, it may be better to set up a branch structure to ease the process of setting up and winding up (if the project is unsuccessful).

However, regulatory laws in jurisdictions such as Brazil and Nigeria require an international investor to set up a ‘company’ form of business presence for acquiring an interest in the assets.

profit and exit

Corporate taxation of profits earned from oil and gas activities in local countries cannot be mitigated or optimised. However, the tax cost on repatriation of profits and exit could possibly be optimised. By structuring the acquisition through tax-efficient jurisdictions, international companies optimise the tax cost on profit repatriation and exit through an applicable tax treaty.

However, in order to extract a greater share of profits from natural resources, many developing countries are bringing the indirect transfer of assets located in their countries within the tax net.

Another emerging issue in recent years, under consideration of foreign multinationals, is the structuring of investments in developing nations through a jurisdiction that has a ‘bilateral investment treaty’, or BIT, with the operating (local) jurisdiction.

Protection of investment

In 2007, the then Venezuelan President Hugo Chavez forced oil producers operating in his country into joint ventures as minority partners with Petroleos de Venezuela SA, the Venezuelan NOC, by offering a disproportionate consideration for their interest. This was rejected by Exxon Mobil and ConocoPhillips, which demanded a consideration in line with their interest in the assets. Chavez responded by nationalising the companies’ assets in Venezuela.

Structuring investments in developing nations through a jurisdiction that has a BIT may potentially safeguard international investors against any adverse action by local governments.

As acquiring oil and gas assets abroad is critical for companies in this sector, it is imperative that they consider and manage the local tax and regulatory issues in a structured manner, so as to mitigate non-business risks.

(Vaibhav Luthra, Senior tax professional, contributed to the article.)

The author is Associate Director, Tax & Regulatory Services, Ernst & Young