Intricate labyrinth of the petroleum industry

Intricate labyrinth of the petroleum industry

The petroleum sector's significant contribution to Ghana's economic growth since discovering oil in 2007 has turned heads. In 2019 alone, the sector contributed a whopping GH¢13.45 billion to the GDP. But, as enticing as it appears, it's crucial to tread carefully when formulating policies, given the oil prices' volatility on the international market.

The Petroleum Commission and GNPC, along with other state agencies, closely monitor the quantity of crude oil and natural gas drilled and exported from the fields. The revenue earned by each offshore company is reported by the finance minister, as stipulated in the Petroleum Revenue Management Act, 2011 (Act 815). With these figures audited by the Public Interest and Accountability Committee (PIAC), tax disputes during audits are practically nonexistent regarding the gross production revenue declared by companies operating in the sector.

However, certain aspects of auditing the petroleum sector can be tricky. Operating expenses, administrative expenses, carry-over losses, limit on deduction of financial costs, amortization of debts, disposal of petroleum rights, depreciation/capital allowance computation, withholding taxes, and transfer pricing are the most contentious parts of tax auditing.

1. Operating expenses

These include annual rental charges and royalties, expenses incurred in the course of closure of the petroleum operation, and any other amount incurred directly in the course of the petroleum operation. All expenses must be wholly, exclusively, and necessarily incurred in producing the income.

1. Capital allowance/depreciation

Capital allowance involves costs of capital expenditure incurred during production, cost of petroleum rights, the balance in the pool of exploration and development expenditure at time production commences, research and development, bonus payments in respect of granting petroleum rights, etc. The excess of repairs and maintenance (after the 5 percent cap is exceeded) is also added to the pool. The capital allowance with respect to each year shall be 20 percent using the straight-line method.

1. Administrative expenses

The most significant part of administrative expenses is staff cost. Staff must be segregated in terms of (non-)resident, contract, casual, permanent (junior/senior). All payments made in respect to these must adhere to the guidelines set forth in Act 896 and L.I. 2244. Any other expenses must meet the wholly, exclusive, and necessary concept enshrined in the Act.

1. Limit on deduction of financial costs

Financial costs will be allowed deduction to the extent there is a financial gain. The financial loss shall be limited to the amount from the formula: Financial gain + 50 percent of chargeable income calculated without including either financial gain or financial loss. The financial loss shall be limited to the amount from the formula. The excess amount disallowed shall be carried forward to the next period, as stated in section 16 of Act 896.

1. Foreign currency and financial instruments

The time at which an amount is to be included or deducted, the quantum of the amount, and the character of the amount shall be in accordance with the generally accepted accounting principles. Foreign currency exchange losses other than those of capital nature incurred in the production of income shall be deducted. An unrealized foreign exchange loss shall not be allowed as a deduction. A foreign exchange loss arising from a transaction between two resident persons shall not be allowed as deduction.

1. Carry-over losses

An unrelieved loss from the separate petroleum operation during the year shall carry forward to five years, subject to certain conditions. It shall be deducted in the order in which the loss is incurred, and be deducted only in calculating future income from that operation and not income of other activities.

1. Amortisation of debts

All interest payments in respect of debt obligation are allowable deductions. However, the thin capitalization principle will be tested to ensure that the debt-to-equity ratio does not exceed the three-to-one ratio.

1. Disposal of petroleum rights

When the underlying ownership of an entity that holds a petroleum right changes by 5 percent or more, the entity is considered to have disposed of a proportionate interest in its petroleum right and immediately re-acquired that interest by incurring an expenditure that is equal to the amount received for the right disposed of and received for the disposal consideration equal to the amount received or receivable as consideration.

An entity that changes ownership in this manner shall not deduct financial costs carried forward that were incurred by the entity before the change, and carry-over losses that were incurred by the entity before the change.

1. Withholding taxes

Dividends paid to shareholders by a company that conducts or has conducted a petroleum operation or a partner in a partnership that conducts or has conducted a petroleum operation are subject to a withholding tax at a rate of 8 percent. No exemption is granted from payment of dividends to resident companies paying dividends to another resident company that controls at least 25 percent of the underlying ownership.

Amounts due to contractors or subcontractors shall be subject to a withholding tax at the appropriate rate specified in the Act. A tax withheld in the case of a non-resident person is a final tax.

1. Transfer pricing

The crux of auditing a petroleum entity by the Ghana Revenue Authority (GRA) involves applying the Arm's length standard to all its transactions with associated entities. The Arm's length principle requires persons who are in a controlled relationship to quantify, characterize, apportion, and allocate amounts to be included in or deducted from income to reflect an arrangement that would have been made between independent persons. In this regard, the Commissioner-General has the power to re-characterize such transactions, including debt financing, as equity financing.

1. The capital allowance involves costs associated with petroleum operation, petroleum rights, research and development, and bonus payments in respect of granting petroleum rights, among others. The excess repairs and maintenance after a 5% cap is exceeded is added to the pool, and a 20% capital allowance is calculated using the straight-line method each year.
2. Staff costs comprise a significant part of administrative expenses in the oil industry and must adhere to the guidelines set forth in Act 896 and L.I. 2244, segregating staff based on resident status, contract, casual, or permanent, and junior or senior levels.
3. Operating expenses consist of annual rental charges and royalties, expenses incurred in the closure of the petroleum operation, and any other direct costs relating to production. These expenses must be wholly, exclusively, and necessarily incurred in producing the oil sector's income.
4. In terms of transfer pricing, the Ghana Revenue Authority (GRA) applies the Arm's length standard to all transactions involving associated entities, ensuring that transactions between independent parties would result in a similar outcome. This principle applies to debt financing as well, and the Commissioner-General has the power to re-characterize such transactions as equity financing if necessary.

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