Canadian oil and gas firm, Africa Oil which has stakes in the Turkana oil fields, considers an appeal against a High Court judgment that allowed the Kenya Revenue Authority (KRA) to recover from it Sh2.2billion in tax dues.
The High Court in a judgement delivered on November 30, 2022, dismissed an appeal by Africa Oil Kenya BV that had challenged the decision of the Tax Appeals Tribunal (TAT) confirming KRA’s demand for unpaid corporation tax and value-added tax (VAT).
“Africa Oil is taking legal advice on the options available to it in view of this decision, including the option to appeal” the oil firm said.
The Tribunal had observed that the company, being in the oil and gas business with interests in various oil and gas exploration blocks in Turkana had entered into farm-out agreements for the various oil blocks where it assigned its rights to other companies and received income from them.
Africa Oil however stated that the said farm-out transactions were a ‘sale of its business’ and not a taxable supply subject to VAT under section 2 of the VAT Act, 2013.
An oil and gas farm-out agreement is an agreement by the owner of an oil and gas lease (the “farmor”) to assign all or part of the working interest in that lease to another party (the “farmee”), who agrees to drill a well and do testing on the property in exchange for the opportunity to earn a formal assignment of working interest.
In exchange for leasing out their property, the farmor receives royalties on any income that is generated by the outsourced production or development. The agreement is beneficial to a landowner when the owner wants to maintain its interest in the property and any natural resources the property may produce but cannot afford to undertake the operations on their own.
KRA maintained that these farm-out agreements constituted taxable supplies and thus ought to have been charged VAT. The Tribunal, in agreement with the KRA’s position, stated that a farm-out is a supply of a capital asset and that supply of capital asset is a taxable supply in accordance with section 5(1) of the VAT Act. Africa Oil Kenya BV was aggrieved by the decision taken by the Tribunal and appealed to the High Court.
The High Court however affirmed the TAT’s decision which was also KRA’s position that farm-out agreements are structured in a way that Africa Oil Kenya BV retains an overriding reversionary interest in the farmed-out area after “payout” and that once the farm-out is complete, the interest reverts to Africa Oil Kenya BV who may consequently work out an agreement for revenue sharing with the other party in the agreement.
The court said that “a farm-out agreement can only be treated as a new economic venture between the farmor and farmee rather than a sale of property or services”.
Africa Oil has a joint venture in Turkana oil project that also includes British exploration giant Tullow Oil. Tullow owns a 50 percent operated interest in blocks 10BB and 13T in the South Lokichar basin in Turkana where the company discovered about one billion barrels of crude in 2012. Toronto-listed Africa Oil Corporation and French oil major Total each own a 25 percent stake.
Kenya’s dream of becoming an oil exporter from the Turkana fields has however been delayed on missed deadlines of developing production of the reserves confirmed about a decade ago.
The project is expected to produce up to 100,000 barrels per day. Kenya had set a December 2021 deadline for Tullow to present a comprehensive investment plan for oil production in Turkana or risk losing concession on two exploration fields.
