On 17 December 2021 National treasury issued a tax policy discussion paper (discussion paper) on "what is the most appropriate tax regime for the oil and gas industry?". Government wishes to evaluate whether the tax regime for the upstream petroleum industry (within the wider fiscal policy context) is suitably designed to create a balance between attracting investment and generating an appropriate level of government revenue, while simultaneously enabling South Africa to achieve its commitments in respect of climate change. Below are key proposals made in the discussion paper together with our brief comments where relevant.
State participation
At the heart of the Upstream Petroleum Resources Development Bill, is the State's participation, regulation of the upstream oil and gas industry as well as the intention to replace certain parts of the current Mineral and Petroleum Resources Development Act 28 of 2008 (MPRDA). Once promulgated, the bills will grant the State a 20% "carried interest" in the production/revenue of an oil and gas project reduced by the State's proportionate share of exploration and production costs. Cost recovery for investors is 50 and 100 per cent in respect of the State's proportionate share of exploration and production costs, respectively. As explained in the discussion paper, the notion of "carried interest" essentially a means for the State to benefit from the proceeds of an oil and gas project without making any upfront cash investment. The carried interest means that the State will only start receiving its share of production / revenue after production commences. Under this model, it is the investors who bear all the risk should there be no commercial discovery made.
The discussion paper propose that the share of the state participation will come through National Revenue Fund thus the South African Revenue Service (SARS) and not to any state-owned entity or another government department. This consideration is welcome given that SARS has extensive knowledge and experience in the sector and the fact that recent development in the country, particularly on the state capture cast a significant doubt on the channeling of the funds to any state-owned entities or government departments. Of interesting to note is that the state will, however, not be passive and only collect its share of revenue, the discussion paper provides that the state through the department of Mineral Resources and Energy (DMRE) will be involved in the strategic and operations management of the of oil and gas projects. We are yet to see how the intertwine between SARS and DMRE will pay out.
Flat rate of Royalty
Another key proposal is a flat-rate royalty of 5 per cent (as defined in section 6 of the MPRDA, 2008) to be levied on gross sales of oil and gas companies. The current royalty regime imposes a royalty on variable rates depending on the profitability of the company. The current regime requires an adjustment for a number of input factors in a complex formula which result in the rate fluctuating between the minimum of 0.5% to 5%. The discussion paper seems to advocate that a flat royalty would make the determination of the royalty simple and easier for both revenue authority and companies to administer.
Fiscal stability agreement
Another key consideration is whether or not government should continue with the issuance of new Fiscal stability agreement (FSA), what these agreements should include if there is a continuation. Fiscal stability agreements are currently provided for in the Tenth Schedule to Income Tax Act and the MPRDA. Investing in exploration, development and production of oil and gas resources is an expensive exercise with long time horizons. From this perspective, it is understandable that investors want certainty in this regard. For the past 7 years, government has not approved any FSA. The discussion paper does not provide reasons why there was no approval of the FSA. Whether is because no applications were received or applications were declined. However, if the State acknowledge that the industry is characterized by significant cost and investors faces the risk of partnering with the state on the proportionate share, then one will expect that these companies should instead be given as much certainty as possible regarding the State's share of taxes. In light of some of the commercial, geological, and political risks which causes investment anxiety within oil and gas as indicated above there is a strong need for continuity of FSAs to encourage investors to commit to long-term projects within the oil and gas industry. Lack of fiscal stability agreements may hamper growth and development within oil and gas industry in South Africa.
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