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IMF Evaluates South African Oil Sector Tax Reform

by Lorys Charalambous, Tax-News.com, Cyprus

04 August 2016


In a recent Technical Assistance Report, a staff mission from the International Monetary Fund (IMF) provided analysis for the Davis Tax Committee (DTC) on tax reform in South Africa's oil and gas sector.

South Africa does not yet have significant proven oil and gas reserves. However, declining coal resources and the relative cost of coal-produced electricity and petroleum is causing South Africa to try and diversify its energy mix.

The DTC, which was set up in 2013 to comprehensively review the country's tax system, has recognized the "potential instability" of the current oil and gas tax regime, in the event that the ongoing offshore oil exploration and onshore shale gas exploration prove to be successful.

The IMF noted that the DTC's focus was on "defining a robust and stable fiscal regime appropriate to the South African context, with a focus on maintaining a palatable regime for investors. … The importance of revenue generation was also highlighted, given the current urgent revenue needs."

The IMF mission's analysis covered the fiscal areas requested by the DTC's oil and gas subcommittee. These included alternative royalty rates (two or five percent, although the DTC appears to favor the latter); alternative capital depreciation treatments; and alternative rates for an additional "rent capture" element in the form of a state participation interest or cash flow surcharge.

They recommended that the royalty should have a single flat rate, rather than the current variable rate formula in the overall mining sector. It was decided that a five percent flat rate would be "modest by international standards, allowing some early revenues from petroleum developments without acting as a deterrent to investment. At such levels, there is no need to distinguish between the offshore and onshore sectors in terms of the royalty rate."

The IMF staff also suggested that the current immediate expensing against corporate tax of capital expenditure, and the 100 percent and 50 percent uplifts for exploration and development expenditure, are "overly generous and will lead to a both revenue loss and a long delay before revenue is collected."

A slower five-year straight line treatment was recommended by the IMF mission. However, the DTC has requested additional modeling analysis to assess alternative reforms to capital depreciation treatment, including a move to the accelerated depreciation treatment currently applicable to the manufacturing sector (a straight line scheme over four years at percentages of 40:20:20:20).

"The need to be able to tax resource rents in the event of a windfall, and the potential instability of the current regime in the event of a large discovery," was also emphasized by the IMF mission. It was suggested that "an additional rent tax mechanism allows the state to receive a portion of the resource rents as they arise."

It was recognized that, "while the subcommittee is open to a cash flow surcharge, since the [draft Mineral and Petroleum Resources Development Act legislation] already contains a provision for 20 percent state participation (an increase from the 10 percent interest currently contained in petroleum production rights), a political preference for the state participation option may prevail."

Finally, it was noted that the subcommittee expressed concerns that South Africa's proposed carbon tax would add a further tax burden on oil and gas companies. The IMF staff concluded that, "as currently drafted, carbon tax would have the effect of a royalty instrument on petroleum rights holders." As a consequence, the DTC requested further illustrative analysis on the impact of the carbon tax on a petroleum project.

TAGS: South Africa | compliance | tax | investment | business | tax compliance | royalties | energy | law | International Monetary Fund (IMF) | corporation tax | oil and gas | legislation | carbon tax | tax breaks | tax reform | business investment | Africa | Tax

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