BBP Law Inc. reviews the fiscal and legal “must haves” for foreign IOC’s doing business in South Africa
The South African oil and gas industry has over the last six years seen steady growth and a significant increase in foreign investor interest. Although still perceived by many as being frontier and although there has been very little exploration success that has translated into oil and/ or gas production projects, the recent entry of notable foreign independent oil and gas companies (IOC’s) such as Shell, ExxonMobil, Total and Cairn India has arguably triggered a second glance by detractors and a renewed sense of urgency to acquiring offshore and onshore oil and gas acreage in South Africa. As most of the offshore and a large percentage of the onshore acreage are currently occupied by IOC’s, the window for new applications is fast closing in South Africa. The entry level requirements and the costs associated with new applications are generally regarded as low. An application for a reconnaissance permit, technical co-operation permit (collectively “petroleum permits”) or exploration right or production right (collectively “petroleum rights”), can be submitted to the Petroleum Agency of South Africa for a nominal non-refundable application fee, the cost of which currently ranging between R 100.00 and R5000.00. The acreage rental fee in respect of which a petroleum right has been granted is as follows: onshore petroleum rights start at R1.00 per hectare with minimum of R1000.00 offshore petroleum rights start at R200.00 per square degree pro rata with a minimum of R50 000.00. Upstream Training Trust (“UTT”) contributions are utilized for building a local skills base in fields related to oil and gas industry, these contributions are currently calculated as follows at R1.00 per hectare with a minimum of R1000.00 and at R200.00 per square degree pro rata with a minimum of R50 000.00. These factors have contributed toward the scramble for available oil and gas acreage in South Africa.
Once an application for a petroleum permit or petroleum right is granted by the Minister of Mineral Resources, one of several undertakings required of an IOC acquiring a technical co-operation permit or petroleum right is compliance with ‘Applicable Laws’. The concept of ‘Applicable Laws’ and the requisite compliance therewith is embedded in the standard form technical co-operation permit, exploration right and production right. The extent of the undertaking to comply with Applicable Laws is often overlooked due to the diverse and complex network of laws in South Africa and clarity on its meaning is hardly obtainable from the definitions clause of the petroleum permit and right, which simply states that ‘Applicable Laws shall mean the laws of the Republic of South Africa’. However, as the South African oil and gas industry evolves and shifts focus from new applications to the transfer of petroleum rights it becomes critical that IOC’s seeking to farm-down and transfer their interest unpack the Applicable Laws’ obligations alongside all its other obligations.
As a starting point to unpacking the Applicable Laws obligation, IOC’s should note that in terms of the Companies Act of 2008, a foreign company may conduct its business in South Africa in its own name either through a South African branch or a South African subsidiary. A South African branch of a foreign company must register with Companies Intellectual Property Commission (“CIPC”) as an external company within twenty one (21) days of establishing a place of business in South Africa or owning immovable property in South Africa. The branch does not exist as a separate locally registered company and it is required to file its annual tax returns and its annual financial statements with CIPC. The branch is not required to appoint a local board of directors and can therefore have the same board of directors as the foreign company. It however must appoint an auditor practicing in South Africa as well as a public officer who is resident in South Africa. Branches may be converted to a local private subsidiary company in South Africa. IOC’s who hold a petroleum permit or petroleum right are regarded as “conducting business in South Africa” and as such are required to register either a branch or incorporate a subsidiary company in South Africa.
Income Tax Act, transfer duties and value added taxes (‘vat’)
In summary terms, the extent of tax obligations imposed on IOC’s depends upon the residency of the IOC in terms of the provisions of the Income Tax Act of 1962, as amended (“ITA”). The ITA defines a resident, in relation to juristic or legal entities, to mean any person that is incorporated, established or formed in South Africa or which has a place of effective management in South Africa. Branches of offshore companies will not fall within the definition of resident. Non-residents are taxed on income from a South African source, or from a source deemed to be South African and also on capital gains arising from the disposal of immovable property situated in South Africa held by that nonresident, or any interest or right in immovable property situated in South Africa and/ or the disposal by the non-resident of any asset which is attributable to a permanent establishment of that non-resident in South Africa, unless a Double Taxation Agreement exists and provides otherwise. In this regard it is important to note that any disposal and transfer of a petroleum right in South Africa will require the transferring deed to be registered at the Mineral and Petroleum Titles Registration Office. Part of this registration process requires the issue of a transfer duty certificate from the South African Revenue Services (“SARS”) confirming that transfer duty has been paid to SARS. Transfer duty is payable within six (6) months of the date of transfer and is payable by the purchaser on a sliding scale of eight percent (8%) of amounts exceeding R1 500 000.00 of the total fair value (SARS may attribute the consideration paid as the total fair value). In terms of the Transfer Duty Act of 1949 an exemption from the responsibility to pay transfer duty is provided for if the transaction constitutes a taxable supply of goods for Value Added Tax (“VAT”) purposes. To qualify, both parties to the transaction should be registered in terms of the Value Added Tax Act as vendors. Ordinarily, value added tax is accounted for at fourteen percent (14%), and thus the purchase price is invoiced together with fourteen percent (14%) VAT thereon. The purchaser would then pay the VAT and account for it as an input VAT payment and claim such VAT payment as a refund from the SARS (“output VAT”). It is equally important for IOC’s to note that special tax rules aiming to incentivise IOC investment in exploration and production activities are contained in the Tenth Schedule of the ITA. In addition, the Tenth Schedule of the ITA authorises the Minister of Finance to conclude binding Fiscal Stability Agreements with holders of petroleum rights in South Africa, so as to ensure that the provisions and dispensations granted by Tenth Schedule as at the date of the grant of the petroleum right applies to holder of the petroleum right for the duration of such right.
The Royalty Act
The Royalty Act of 2008 and the Royalty Administration Act of 2008 came into operation on 1 March 2010. Both govern the administration and payment of royalties to the State by IOC’s in respect of the transfer of mineral resources extracted from within the Republic. The Royalty Administration Act provides that an IOC who holds a petroleum right qualifies to register, and must register, with the Commissioner for Revenue Services for the payment of royalties. The Royalty Act also provides that an IOC who “wins or recovers” a “mineral resource” extracted from within the Republic of South Africa qualifies to register for the payment of royalties in terms of the Royalty Act. Thus, oddly, holders of petroleum rights are required to register in terms of the Royalty Administration Act, although they only become liable to pay royalties if they extract and transfer mineral resources. The rationale for premature registration for payment of royalties as contained in the underlying legislation is unclear and unreasonable when applied to the holder of an exploration right. This requirement nevertheless makes the ‘must haves’ list for IOC’s doing business in South Africa. Section 13 of the Royalty Act authorises the Minister of Finance to conclude binding Royalty Stability Agreements with an extractor in respect of an extractor’s mineral resource right or in anticipation of the extractor acquiring a mineral resource right. Royalty Stability Agreements are limited to specified mineral resource rights and include prospecting rights and exploration rights. These fiscal stability agreements guarantee that certain terms and conditions apply in respect of the right, as long as the extractor holds the right. Royalty Stability Agreements stabilise the rate formulae and if legislative amendments occur that result in a higher royalty becoming payable, such legislative amendments will have no force and effect to the extent of the agreement that has been concluded between the Minister of Finance and the IOC.
In conclusion, in addition to compliance with all other obligations, our summary list of the “must haves” for IOC’s seeking to comply with the Applicable Laws obligation and in order to obtain maximum benefit from the special rules and dispensation available to IOC’s includes: the incorporation of a subsidiary company along with the accompanying VAT registration, a Fiscal Stability Agreement to be entered into with the Minister of Finance in terms of the ITA, a Royalty Stability Agreement entered into with the Minister of Finance in terms of the Royalty Act and registration with the Commissioner for Revenue Services for the payment of royalties. These ‘must haves’, in combination with all other associated obligations, will in our view not only ensure compliance with the Applicable Laws obligation but also achieve positive due diligence results and simplify farm-downs and corporate transactions.