Court gives KRA nod to get Ksh2.3b from oil firm

Tuesday, December 6th, 2022 01:00 | By
New CRA team must share resources well
Kenya Revenue Authority. PHOTO/Courtesy

A Canadian oil and gas firm, Africa Oil Kenya BV has suffered a blow after the High court allowed Kenya Revenue Authority (KRA) to collect over Sh2.2 billion in tax arrears.

The taxman will now collect Sh2,293,334,065 from Africa Oil being unpaid VAT for the years 2011,2012 and 2015.

In a judgment delivered by Justice David Majanja, he allowed the Commissioner of Tax to demand money from the Canadian company arising from value-added tax (VAT) on farm-out transactions between 2011 to 2015.

Challenge decision

KRA was allowed to collect the tax arrears after the judge dismissed an appeal by Africa Oil Kenya BV that had challenged the decision of the Tax Appeals Tribunal confirming the demand for unpaid Corporation Tax and VAT.

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. 

An audit carried out by KRA on the company’s farm-out transactions indicated that it assigned its exploration rights for Blocks 12A, 13T and Block 9 to third parties: Tullow Oil, Marathon Oil and Maersk Oil in 2011,2012 and 2017 and earned income and did not pay taxes for the same.

The company, 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.    A farm-out agreement is most commonly used in the oil, natural gas, and mineral industries.

It is an agreement signed by an owner of property known as “farmor”, when leasing their resource-producing property to another person called a “farmee”, for the purposes of development.

In exchange for leasing out their property, the farmor receives royalties on any income that is generated by the outsourced production or development.

It was the position of KRA 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 dissatisfied with the decision taken by the Tribunal and appealed to the High Court objecting to the same seeking to set aside the assessment stating that the same was unlawful.

 However, KRA opposed the appeal on grounds that the income from the firm’s farm-outs was a separate and specified source of income that ought to have been treated differently from its normal business income.

Reversionary interest

In his decision Judge Majanja affirmed the Tax Tribunal’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 once the farm-out is complete, the interest reverts to the company who may consequently work out an agreement for revenue sharing with the other party in the agreement. 

The court held that “a farm-out agreement can only be treated as a new economic venture between the farmer and farmer rather than a sale of property or services”

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