Economists Critique Petroleum Income Tax Law
Joyce Owusu-Ayim, an economist with GTZ's Good Financial Governance Programme in Accra and Dr Joe Amoako-Tuffuor, a tax policy advisor at the Ministry of Finance & Economic Planning, have noted that the absence of thin capitalization provisions in Ghana's Petroleum Income Tax Law (PITL) is a potential setback to government's ability to capture rent.
In a joint paper on the theme: 'An Evaluation Of Ghana's Petroleum Fiscal Regime,' launched recently in Accra, the economists pointed out that 'while the Internal Revenue Act (IRA), 2000 (Act 592) contains a thin capitalization provision of 2 to 1 debt to equity ratio, that provision to date is not applicable to petroleum operations, nor is it enforced in the case of mining.'
Thin capitalization provisions provide a way, albeit an imperfect one of preventing IOCs from avoiding domestic corporate income taxes.
They further explained that 'even when the planned repeal of the PITL is carried out and petroleum income tax provisions are folded into the IRA, it is unlikely to have any consequential effect because of the fiscal stability provision in existing petroleum agreements.'
According to them, closely related to thin capitalization provision is the fact that the interest expense and dividends are not subject to final withholding tax.
'What that means is that a contractor with high debt to equity ratio will most likely understate taxable income through the deduction of high interest expense and as a result be able to shift profits to a foreign jurisdiction at the expense of the host country. No less worrisome is the provision that withholding taxes 'may be waived …where the subcontractor is an affiliate of the contractor whose services are charged to the contractor at cost' (PITL (1987) Section 27).
They described the fore-going as an invitation for abusive transfer pricing since it was difficult to determine whether a related company was providing services, especially management related expenses at cost.
Also, the economists said the withholding tax on employees may be subject to individual contractual variation – (PITL (1987) Section 28).
'Since most industrialized countries tax foreign income but give tax credit for taxes paid to foreign governments, it seems unreasonable that there should be a leeway for exemption from taxes on income earned within a country's borders, if we consider that the percentage of income paid to expatriate employees may be considerable. Anecdotally, even the 183 days residency requirement is routinely breached or not enforced.'
On ring-fencing – a limitation on consolidation of income and deductions for tax purposes across different activities, or different projects undertaken by the same taxpayer, they noted that in the Ghana's fiscal regime, consolidation of companies under common control is not permitted. However, the regime permits cost recovery deductions from one licence area against production from another licence area by a single company.
'The downside of this is that even this limited ring-fencing provision can lead to revenue delays for the government because an investor who undertakes a new project will be able to deduct exploration or development expenditures from the new project against the income of existing projects that are generating taxable income.
But strict ring-fencing may not necessarily be appropriate either. More exploration and development can be stimulated if taxpayers are allowed a deduction against current income, which will generate more government revenue in the long run as the taxable base increases.'
The choice between opting for modest early revenues as against higher revenues in the longer term depends on the government's fiscal objectives and preference. One safeguard against current revenue losses to government is the use of cost recovery limits, which is noticeably absent in Ghana's regime. The implication here is that net of royalty as a percentage of production volume, the rest of annual production could be devoted to cost oil, if required, leaving zero profit oil.
Furthermore, they touched on transfer pricing – the act of pricing goods and services given for use or consumption to a related party (e.g. subsidiary of a company). Governments try to discourage transfer pricing manipulation which occurs when a company fixes the transfer price on a non-market basis resulting in saving the total tax liability of the company by shifting accounting profits from high tax to low tax jurisdictions.
They noted that most countries have explicit provisions in their tax laws that enable a price adjustment to be made where under or over-pricing between related companies results in a lowering of taxable profits.
The research states: 'There are no such explicit provisions in Ghana's PITL. The Petroleum (Exploration and Production)
Law (PNDCL 84) contains a weak provision: '…petroleum operations to be carried out under this Law shall be on the basis of prevailing international competitive prices and such other terms as would be fair and reasonable.'
The paper indicated that the Internal Revenue Act which contains a provision that gives the revenue authority powers to deter abusive transfer pricing.
It therefore called for similar provisions to be echoed in the PITL even though it said the capacity to enforce such provision was however doubtful.
'The regime does not provide for standardization of the fiscal terms. And with no apparent safeguard for contract transparency, this leaves the State's take of the resource rents from petroleum production subject to potentially ad-hoc negotiations with IOCs, vulnerable to corruption, and susceptible to sub-optimal financial outcomes,' it emphasised.
BY Samuel Boadi