Expert Insight

Capital Gains Tax - The New Resource Nationalism?

The traditional method by which governments take advantage of the natural resource exploration and production activities carried out by international companies in their region is both to charge a licence fee for the right to explore and produce within a particular area and to collect royalties, corporate taxes or customs duties from those companies based on the amount produced. However, a growing trend has emerged whereby governments in natural-resource rich countries have another potential weapon in an effort to capture revenue. Many are now seeking to impose a capital gains tax on gains realised by international (non-resident) companies from non-resident or overseas transactions where the value is derived from assets based within their jurisdiction (other than real estate which have traditionally been captured under international double tax treaties, many being based on Article 13(1) of the OECD Model Treaty). Mozambique is one such government in the news of late as seeking to implement these changes.

Mozambique: the Cove Energy plc takeover

There has been intense pressure on the Mozambican state to increase its portion of any revenues achieved from natural resources within the territory, particularly in light of the recent failure of the state to collect any taxes in respect of the sale of Riversdale Mining to Rio Tinto for US$3.9 billion.

This pressure presumably led to Minerals Minister Esperanca Bias announcing in March this year that Mozambique plans to impose capital gains tax on the proposed public takeover of Cove Energy plc, the UK-listed oil and gas exploration and production company with a 8.5% stake in an large offshore gas field in the Rovuma basin. This will involve the creation of a new law that imposes capital gains tax on the sale of non-Mozambican companies who have assets within the region. It had originally been expected that Cove as a foreign company would avoid having to pay the tax as it was not selling the Mozambican assets direct. Following Minister Bias’ announcement there was a dip in Cove’s share price amid uncertainties over the level of tax to be applied. This recovered somewhat on 10 April when the government confirmed that the effective rate of tax would be 12.8%, far less than had been anticipated. By way of contrast, in February Mozambique received nearly AUS$72 million (about £46 million) in capital gains tax from the Australian Talbot Group following its divestiture of its shares in Minas de Revuboè, the Mozambican coal exploration company. This amount represented a rate of 40% capital gains tax on the amount realised by the Talbot Group.

The Cove sale is now proceeding although initially it was not clear who the buyer would be. Royal Dutch Shell plc initially beat off competition from Thai company PTT Exploration and Production by increasing its US$1.8 billion offer to include a promise to pay Cove’s capital gains tax, stating that this additional liability would add a further US$200 million to the bill for the acquisition, a significant sum which took the total price to be paid for Cove to approximately US$2 billion. PTT is now the preferred bidder in respect of its higher offer of US$1.9 billion plus a similar commitment to pay the resulting capital gains tax with Shell effectively out of the running having not increased its bid in time.

The capital gains tax regime must be distinguished from the corporate tax and royalties regimes. Minister Bias’ announcement on capital gains tax reinforces her pledge in November 2011 that Mozambique would not be following in the footsteps of Zambia and Ghana, who raised royalties and corporate taxes respectively on mining companies last year. This was confirmed again in February 2012 when she stated that the raft of new mining laws being introduced will relate solely to operational efficiencies and the imposition of rules on energy companies requiring them to develop local communities where mines are based. Her rationale for this is that existing taxation rates are already set at a level similar to other African nations and because exploration and production activity is inherently risky, it would not be just to increase royalties or corporate taxes further. The implication is that Minister Bias and the Mozambican government are aware of the need to ensure Mozambique remains an attractive prospect for foreign direct investment and this clear commitment on royalties should give investors some comfort on the costs of doing business in Mozambique. A positive step, since the country is currently benefiting from recent discoveries of large gas fields offshore and a huge coking coal mine located in the Tete province.

Uganda: ongoing disputes between Heritage Oil plc, Tullow Oil plc and the Uganda Revenue Authority

In respect of the Cove takeover the Mozambican government took a clear stance on what they expected in terms of capital gains taxation prior to signing of the deal. By contrast there was no such clarity in relation to the raft of ongoing capital gains tax disputes between Heritage Oil plc, Tullow Oil plc and the Uganda Revenue Authority (URA). The first of these disputes involves Heritage’s contention that it is not liable to pay any capital gains tax on its sale of Ugandan oil fields to Tullow for US$1.45 billion because the transaction was not executed in Uganda. The Ugandan Tax Tribunal disagreed, stating that it was the location of the assets which formed the subject matter of the sale that was the pertinent issue rather than the jurisdiction in which the sale took place, and ordered Heritage to pay the US$404 million bill plus the government’s costs. This dispute is now subject to arbitration in London and Heritage has paid US$121 million to the Ugandan government by way of a deposit pending resolution of the case.

The second dispute, though related to the first, is a little less straightforward. Following the sale of Heritage’s Ugandan assets to Tullow in 2010, Tullow was left in the position of having paid US$1.45 billion for assets they could not use without the government’s approval. The Ugandan government, in a surprising move, then required Tullow, concurrently to the arbitration proceedings between URA and Heritage, to pay the balance of US$313 million due on the earlier sale by Heritage. Tullow, desperate to obtain the necessary approval and the rights under production sharing agreements, paid up. They are now embroiled in a legal wrangle with Heritage after instituting proceedings in the commercial court in London to recover this US$313 million with their claim based on an indemnity clause in the sale documents pursuant to which Heritage is obliged to reimburse them for any tax liabilities arising from the sale. Heritage on the other hand are arguing that the payment made to the government was a political payment rather than a tax and that Tullow should bear the consequences of its decision to complete the purchase from Heritage prior to receiving final government signoff of the deal. There is now also a further dispute in the Ugandan Tax Appeals Tribunal between Tullow and the URA over the amount of capital gains tax to be paid by Tullow in respect of its farm down of its interests to Cnooc and Total. In this case, Tullow, while not challenging the principle that capital gains tax is payable on the transaction, is challenging the amount to be paid. The experiences of these companies in Uganda has put into sharp focus the necessity of communication between the host government and inwardly investing companies prior to agreeing such deals to avoid lengthy legal battles post-completion.

India: proposed retrospective changes to capital gains tax assessment

Perhaps the most concerning instance of capital gains tax as a new means of resource nationalism is India’s recent response to the outcome of the high profile Vodafone case. In January this year the Indian Supreme Court gave its ruling on the case confirming that Vodafone was not liable for US$2.9 billion purportedly owed to the Indian Revenue in respect of its 2007 purchase of interests in Cayman registered Hutchison Essar Limited. The Indian Revenue had argued that despite the fact that neither the buyer nor seller were registered in India and the transaction took place outside India, the fact that Hutchison held assets within India gave them jurisdiction to tax the gain. Had the Indian Revenue won on this point it would have meant Vodafone, as the buyer, paying the tax under the withholding provisions. India is now amending its tax code giving the government the retrospective power to tax transactions involving significant Indian assets which took place as far back 1962, as announced in the budget speech on March 16. Unsurprisingly, these plans have resulted in much criticism internationally and the Financial Times reported in April that seven business associations, led by the US Business Round Table and representing the views of businesses in the UK, US, Canada, Japan and Hong Kong, have joined forces to write an open letter to Indian prime minister Manmohan Singh to express their concern over the 2012 Finance Bill. They warn Mr Singh that such retrospective changes would lead to international investors shunning India and state that some of their member companies have already begun ‘re-evaluating their investments in India’ as a result of the uncertainty caused by the proposed new rules. Faced with such opposition the Indian government has pushed back the implementation of these measures for a year, President and former Finance Minister Pranab Mukherjee has attempted to allay investor fears by confirming that taxes would not be applied retrospectively to deals where tax assessment was properly carried out and that the new laws will not affect the operation of any double taxation avoidance agreements already in place.

However, the Finance Bill has been passed and with it comes the introduction of a general anti-avoidance rule or GAAR effective from 1 April 2013 but with retrospective effect starting 1 April 2012. This may have far reaching repercussions for international structures with entities that have no “substantial commercial purpose”. Though guidance is awaited on the meaning of this phrase there is real concern about offshore structures, for example, involving Mauritius intermediate holding companies. This illustrates that the extension of the capital gains tax rules is not the only weapon Governments have to increase their tax revenues. Such structures should be reviewed now with the benefit of detailed advice.


Perhaps the lesson to be learned from these transactions is that international companies need to be constantly aware of the possibility of change within the fiscal regimes of the countries they operate in, particularly in respect of emerging market economies where the legal regime is often left behind the fast paced business environment. Bidders are increasingly required to include potential tax costs in their offer prices. Governments also need to think carefully about the package they are offering for foreign direct investors into their country. The central issue here is one of clarity. International investors need to be able to estimate what the cost of doing business will be in their chosen investment jurisdiction and this inevitably includes determinations as to potential tax liabilities on exit. If there is too much uncertainty surrounding this point they may well decide that the risk of doing business in the country is too great and take their desperately needed foreign direct investment elsewhere. While some countries such as Mozambique seem to be taking care to mitigate the effects of the new developments in capital gains taxation by applying relatively low rates and engaging in dialogue with investors, others appear to be pushing ahead with reforms with little concern as to the potential negative impact they might have on future investment. It will be interesting to see how these differing attitudes affect cross-border structures and the global spread of investment activity over the next few years.

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