The Commercial Division of the High Court of Uganda has ordered the Uganda Revenue Authority to refund $45 million (plus interest) to Heritage Oil and Gas Limited, after ruling that the tax body erroneously computed the Capital Gains Tax (CGT) when omitting to add Heritage’s exploration costs of $150m to the cost base, in the sale of its assets to Tullow Oil in 2010.
Heritage’s consolidated appeal against URA partially succeeded on two grounds – one and three – out of the six it listed in its Notice of Appeal, according to the judgement dated and delivered electronically on December 23, 2024 by Lady Justice Susan Abinyo.
Ground 1 stated thus: that the Tax Appeals Tribunal (TAT) erred in law in its decision relating to TAT Application 26 of 2010 that section 79 (g) of the Income Tax Act applied.
Ground 3 on the other hand stated that the TAT erred in law when it disallowed the addition of the admitted and agreed exploration cost of $150m to the cost base in calculating the capital gain.
Section 79 of the Income Tax Act contains ‘Source Rules’ in subsection ‘a’ to ‘s’ upon which URA determines income sourced in Uganda.
79 (g) states that income is “derived from the disposal of an interest in immovable property located in Uganda or from the disposal of a share in a company the property of which consists directly or indirectly principally of an interest or interests in such immovable property, where the interest or share is a business asset.”
URA had imposed a CGT on the transaction on the ground that the disposal of Heritage’s interests in the exploration license, the Production Sharing Agreements (PSAs) and the Joint Operating Agreement (JOA) was a disposal of an interest in immovable property located in Uganda.
The court has ruled that this was erroneous since what was disposed of was movable property comprised of contractual rights under the PSAs and the JOA and rights to conduct exploration operations under the exploration license.
It is the ruling on the flawed tax computation that stands out however, seeing how hard it will hit the state coffers, with Abinyo stating that “the computation of the CGT excludes the sum of $150m which formed part of the cost base, and therefore not subject to tax.”
CGT is a tax on the profit when one sells or disposes of an ‘asset’ that has increased in value. It is the gain (profit) one makes that is taxed at 30%, not the gross amount received.
Represented by Denis Kusaasira, Festus Akunobera, Joshua Byabashaija and Steven Kabuye from ABMAK Associates, Advocates & Legal Consultants, Heritage successfully argued that the exploration costs of $150m formed part of the cost base (therefore, not a gain) and so should not have been taxed in URA’s computation.
The implication is that URA collected $45m excess tax being 30% of the $150m, wrongly included as part of taxable income. It is this that URA has been ordered to refund.
It does not end there, however, as the tax body will also chip in with an extra 2% ($900,000) per month in interest on the $45m, going back to April 7, 2011 when the excess tax was collected from Tullow Oil by way of an Agency Notice.
As of December 23, 2024 when the ruling was delivered, 165 months have since elapsed; bringing the interest due to Heritage to $148.5m. In addition to the excess tax, therefore, URA owes Heritage at least $193.5m, starting on the date of judgment.
Furthermore, court also awarded Heritage a quarter of the costs of the appeal, and in the TAT. According to the ruling, interest on these costs was set at a rate of 6% per annum from the date of the judgment until payment is made in full.
Background
Before the discovery of commercial deposits of oil and gas in 2006, Heritage together with Energy Africa (U) Ltd entered into PSAs with the Government of Uganda in relation to Exploration Areas 1 and 3A in the Albertine Graben. They were accordingly granted licenses for petroleum exploration, development, and production.
Energy Africa later sold its interests to Tullow, pursuant to which, Heritage and Tullow each held 50% participating interests in the exploration areas.
Heritage, one of the pioneer oil companies in Uganda, was to later make its own oil discoveries in Block 3A.
In a JOA between itself and Tullow, it was stated that in the event that either company wished to dispose of its 50% interest, the other had a right of pre-emption (that is, the first rights to buy the 50% shares owned by the exiting partner).
It is this right that Tullow exercised when Heritage chose to exit Uganda.
Subsequently the two companies entered into a Sale and Purchase Agreement (SPA) on January 26, 2010, by which Heritage sought to transfer its rights under the Petroleum Exploration Licenses for exploration areas in Uganda; it’s participating interests under the JOA and its rights under the PSAs, subject to the satisfaction of various conditions precedent.
The amount to be received by Heritage from Tullow in the transaction comprised of the base price of $1.35b, paid under the SPA, and an addition $100m paid under a supplemental agreement (which in the judgement is called a ‘contingency amount’)
In July of 2010, the Minister of Energy and Mineral Development consented to the sale of Heritage’s assets to Tullow on condition that whatever taxes accruing to the transaction were paid.
URA was later to ask Heritage to pay $404.925m on July 6, 2010 and $30m on August 19, 2010 in taxes in respect to the base purchase price, and the contingency amount respectively, as highlighted above.
However, Heritage objected to the first assessment on August 18, 2010 and to the additional assessment on August 19, 2010. URA followed this by issuing objection decisions on November 12, 2010 and December 1, 2010 in respect of the first assessment and the additional assessment respectively, and maintained the assessments for reasons that the transaction was subject to tax under the laws of Uganda.
Consequently, Heritage filed two applications in the Tax Appeals Tribunal (that is TAT Application No. 26 of 2010 on December 10, 2010 and TAT Application No. 28 of 2010 on December 31, 2010), challenging URA’s objection decisions in respect of its tax liability.
But the TAT dismissed both applications and upheld URA’s assessments.
Heritage being dissatisfied with the TAT’s decisions as well, sought redress at the High Court of Uganda under a consolidated appeal, that is Civil Appeal No. 23 of 2011 and Civil Appeal No.3 of 2012 – hence Abinyo’s ruling, last month.
Apart from grounds (1) and (3) in its Notice of Appeal referenced earlier, Heritage also noted in ground (2) that the TAT erred in law when it held that section 79 (s) of the Income Tax Act applied and in ground (4) that the TAT erred in law in failing to hold that there could be no tax liability by virtue of the “Convention between Mauritius and Uganda for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income” and section 88 of the Income Tax Act, even if (which is denied) there would otherwise have been a tax liability.
Grounds (5) and (6) stated that the TAT erred in law by failing to properly evaluate the evidence before it and also erred in law by saying URA’s assessments were validly issued, respectively.
Court, however, rejected these other grounds (2, 4, 5 and 6) – which ruling was in favour of URA.
The tax body was represented by Catherine Donovan Kyokunda jointly with Tonny Kalungi, Diana Prida Praff, Barbara Ajambo Nahone, Gloria Akatuhurira, and Charlotte Katutu from its Legal Services and Board Affairs Department.
The Error
So how did we end up here? URA appears to have calculated the tax due from the transaction as if it was computing Corporate Income Tax (CIT), since under such a regime Heritage would not have been permitted to deduct the exploration costs (of $150m) as this would be recovered under the PSAs’ cost recovery regime.
However, since Heritage was selling all its assets and rights and getting out of business in Uganda, it would not be able to claim any costs in future per the PSA guidelines. As such the applicable tax process in this case was the CGT regime where the $150m had to be added to the cost base (and therefore excluded from the ‘gain’ or profit).
The taxable gain should therefore have been computed by subtracting total deductions (the signature bonus and the exploration cost i.e. $250,000 + $150,000,000 = $150,250,000) from the base purchase price.
As such $1,199,750,000 (after subtracting $150,250,000 from $1,350,000,000) is the correct taxable gain that should have attracted a CGT of 30%. The correct tax therefore on the gain would have come to $359,925,000 (and not the $404,925,000 as computed by URA).
Therefore, the excess tax collected was $45m because the exploration cost of $150m was not deducted from the base purchase price when calculating the taxable gain, resulting in a higher taxable amount and consequently a higher tax liability.
Going Forward
As per the letter of the law, Heritage’s legal representatives, ABMAK, are expected to serve URA with a draft of the decree and thereafter the latter will be expected to comply with the judgement and the orders of the court.
Could URA choose to appeal, though? Denis Kakembo, the Managing Partner, Cristal Advocates, thinks so.
“Based on recent trends I do not think we are about to see the end of this matter. In practice either of URA or a tax payer who feels aggrieved by decisions of court are at liberty to exercise their right to appeal; even up to the Supreme Court,” he says.
That said, Kakembo is concerned that court decisions of this nature continue to delay.
“Since the TAT ruling, it has taken over a decade for court to reach a decision in this matter. Being commercial in nature however, tax matters should be handled expeditiously. The justice system surely can do better than this,” he says.
Probably this tendency of courts to delay justice could be why URA decides to appeal and therefore further postpone the refund process (especially since such hefty tax reimbursements distort the tax body’s annual revenue targets).
The downside of URA obtaining a stay of execution is that the interest (of 2% monthly) will continue running; meaning even more than the $193.5m (as of December 2024) will be paid to Heritage in case the tax body’s appeal is not successful.
Tullow exited Uganda in 2020
Tullow itself has since left Uganda after selling its stake to TotalEnergies in 2020. The question now is, were similar errors repeated by URA in the computation of the CGT in this transaction as well?
There is also the small matter of the $30m CGT collected on the contingency amount (of $100 million), which court upheld, but Heritage insisted was outside the taxable gain. Will it choose to challenge this again?
All these notwithstanding, at least one would argue that Abinyo’s measured judgement can go a long way in reassuring the business community – local and foreign – that they can find justice in Uganda courts even when aggrieved by the state.
“The oil industry is susceptible to risk, as we have come to find out since we discovered commercial deposits in Uganda. By courts avoiding emotion fueled or rushed decisions, they give would be investors the confidence to spend their money here,” said a legal scholar, who preferred anonymity.
