THE REPUBLIC OF UGANDA

IN THE MATTER OF THE TAX APPEALS TRIBUNAL

TAT APPLICATION NO. 4 OF 2011

 

1. TULLOW UGANDA LIMITED
2. TULOW OPERATIONAL PTY LTD    …….....................………… APPLICANTS

VERSUS

UGANDA REVENUE AUTHORITY ………......................……..……  RESPONDENT

 

RULING

 

This ruling is in respect of an application brought by the applicants challenging initial assessments of income tax of US$ 472,748,128 by the respondent in respect of a transfer of their interests in Exploration Areas EA1, EA2 and EA3 to CNOOC and Total for the consideration of US$ 2,933,330,400. The said assessments were eventually revised by the respondent to US$ 467,271,971 being capital gains tax. The applicants being aggrieved by the said assessments appealed to the Tribunal.

 

This ruling is brought after the Tribunal has complied with S. 13 of the Tax Appeals Tribunal (TAT) Act. Mr. Martin Feeta, one of the members of the panel listening to the dispute passed away on the 20^th May 2014. At the time of his passing away, all the parties had presented their evidence, closed their cases and made their submissions. Delivery of the ruling was pending. At the time of his passing away the then Tribunal had reached a decision. On the 16^th June 2014, when the matter came up for ruling, the parties were informed that the Tribunal did not have the legally required Coram to deliver a ruling. Counsel for the parties agreed that a new member should be assigned to the panel to replace Mr. Martin Fetaa. It was also agreed that matter be reheard by the record of evidence being availed to a new member under S. 13(5) of the Tax Appeals Tribunal Act without the need of recalling witnesses. Mr. Pius Bahemuka was appointed to replace the deceased. The record of the evidence and the submissions of the parties have been handed to him. Though the Tribunal cannot say that this is a ruling of four members as the Coram is three, it can say that this is a unanimous decision. 

 

1. SUMMARY OF CASE

 

The facts agreed upon by both parties are:

 

1. The first applicant, Tullow Uganda Limited (hereinafter called “TUL”), is registered under the laws of the Isle of Man and was formerly Energy Africa Uganda Limited (“Energy Africa”). The second applicant, Tullow Uganda Operations Pty Limited (hereinafter called “TUOP”) is registered under the Corporations Act 2001 in Western Australia and was formerly Hardman Africa Pty Ltd (“Hardman”). The applicants are residents for tax purposes in Uganda.                                                          
2. On the 8^th October 2001, both the applicants and the Government of Uganda (“GOU”) executed a Production Sharing Agreement (PSA) under which they were granted exploration, development and production rights in Exploration Area EA2 (the “EA2 PSA”). It was signed by Hon. Syda N. M. Bbumba, Minister of Mineral and Energy Development for and on behalf of the Government, by Mr. Edward John Ellyard (Managing Director) on behalf of Hardman and by Mr. W.A Nel (Chief Operating Officer) on behalf of Energy Africa.                                                                                                                                 
3. Another PSA, in relation to EA1, was entered into on the 1^st July 2004 (the “EA1 PSA”) between Energy Africa, Heritage Oil and Gas Limited (“Heritage”) and the GOU. The EA1 PSA was signed for and on behalf of the GOU by Hon. Daudi Migereko, Minister of State for Energy, also holding the portfolio of the Minster of Mineral and Energy Development, by Mr. Brian Smith on behalf of Heritage and by Mr. Rhimwaan Gasaut on behalf of Energy Africa.                                                                                                                   
4. Another PSA, in relation to EA3A, was entered into on the 8^th September 2004, between Energy Africa, Heritage and the GOU (“the EA3A PSA”). The EA3A PSA was signed for an behalf of the GOU by Hon. Syda N. M. Bbumba, Minster of Mineral and Energy Development, by Mr. Brian Smith on behalf of Heritage and by Mr. Andrew Wyndham on behalf of Energy Africa.                                                                                                                             
5. Heritage and Energy Africa agreed to continue with the Joint Operating Agreement (“JOA”) between Heritage and Energy Africa entered into on the 29^th August 2002 for EA3, under which the first applicant’s participating interest was 50%.                                                                                                             
6. Prior to 2009, Tullow Oil Plc, the parent company of both applicants, acquired the Energy Africa Group, which had a subsidiary, which later became TUL. Tullow Oil Plc later acquired the Hardman Group, including Hardman Africa Pty Limited, which later became TUOP. Tullow Oil Plc acquired the relevant subsidiaries’ rights and interests in the PSAs in Uganda.                                                                                                
7.  At this stage the interests in the PSAs were as follows:   

a. TUL held 50% of EA1, EA2 and EA3A;

b. TUOP held 50% of EA2; and

c. 50% of each of EA1 and EA3A was held by Heritage and the interests then held by TUL in EA1 and EA3A are hereinafter referred to as “the Other Original Interests”.                                                                                                                                        

1. The applicants through their exploration activities discovered hydrocarbons in the respective exploration areas.                                                                                                                               
2. On or about the 17^th January 2010,  TUL invoked its pre-emptive rights under the JOA for the purchase of 50% participating interests of Heritage in Exploration Areas EA1 and EA3A (the Heritage interests”) at a consideration of US$ 1,450,000,000 (United States Dollars one billion four hundred and fifty million), subject to approval from the GOU.                                                                          
3. On about the 26^th January 2010, TUL and Heritage signed a Sale and Purchase Agreement (the “SPA”) under which TUL would acquire Heritage’s 50% participation rights in Exploration Areas EA1 and EA3A.                                                                                                                                       
4. On the 6^th July 2010, the GOU granted a conditional approval to the transaction between Heritage and TUL.                                                                                                                                               
5. On the 18^th October 2010, the respondent raised assessment number SA/LTO/2569 of US$ 390,924,460 and assessment number SA/LTO/2570 of US$ 84,999,660 on TUL and TUOP respectively being income tax (Capital Gains Tax).                                                                                                                                  
6. On the 1^st December 2010, the applicants objected to the assessments.                                                    
7. On the 24^th February 2011, the respondent made an objection decision that adjusted the assessment on the TUL. The assessment No. SA/LTO/2569 of US$ 390,924,460 was amended to US$ 387,748,469, while assessment No. SA/LTO/2570 of US$ 84,999,660 was unaffected, resulting in a total of US$ 472,748,128.                                                                                                                                                                       
8. On the 15^th March 2011, the applicant, the GOU and the respondent executed a memorandum of understanding (“MOU”).                                                                                                          
9. On the 25^th March 2011, the applicants filed an application for review before the Tax Appeals Tribunal (TAT) contesting the assessments and the objection decision by the Commissioner of the respondent.                                                                                                             
10. TUL acquired the Heritage Interests pursuant to the SPA and upon fulfilment of conditions in the MOU of 15^th March 2011. Following the acquisition the holdings in the Exploration Areas were:    

a. TUL held 50% of EA2 and 100% of EA 1 and EA 3A; and

b. TUOP held 50% of EA2.                                                                                                    

1. The applicants disposed of 66.67% of their interests in EAs 1, 2, and 3A to CNOOC and Total at US$ 2,933,330,400 (United States Dollars two billion nine hundred thirty three million three hundred thirty thousand four hundred).                                                                                                            
2. Following the disposal the holdings are:                                                        

a. TUL holds 33.33% of the interests under the EA 1, and EA 3A PSAs.

b. TUOP holds 33.33% of the interests under the EA2 PSA.

c. CNOOC holds 33.33% of each of the interests under the EA1, EA2 and EA3A PSAs; and

d. Total holds 33.33% of each of the interests under the EA1, EA2 and EA3A PSAs.                                                                                                                          

1. On or about the 22^nd February 2012, the applicants paid US$ 141,824,438 (United States Dollars one hundred forty two million eight hundred twenty four thousand four hundred thirty eight) being 30% of the tax assessed.

 

1. ISSUES

 

The issues agreed upon by both parties are:

 

1. In respect of EA2

 

1.1  Whether Article 23.5 of the PSA for area EA2 covers capital gains/income tax arising from gains derived out of disposal of interests in the PSA?

 

1.2  Whether Article 23.5 of the PSA for EA2 entered into by and between the Government of Uganda acting through the Minister of Energy and Mineral Development is valid/lawful under Uganda Law?

 

1.3  Whether Article 23.5 is valid/lawful under international law?

 

1.4  If the answer of either issue 1.2 or 1.3 is in the affirmative, should Article 23.5 be enforced by the TAT, and if yes do the assessments fall to be discharged or not?

 

1.5  Whether the respondent is estopped by Article 23.5 from raising an assessment in respect of the gains made on the disposal of the applicants’ interest in EA2, and if yes, do the assessments fall to be discharged or not?

 

1.6  Whether the reference to the respondent being estopped includes references to principles rooted in fairness including legitimate expectation?

 

 

 

 

 2. In respect of the other PSAs

 

What is the gain, and how is that gain computed, on the disposal of the interests in the PSAs (a) purchased by TUL from Heritage; and (b) otherwise?

 

3. Reinvestment relief

 

3.1 Whether the applicants are entitled to reinvestment relief under S. 54(1) (c) of the Income Tax Act Cap 340?

 

3.2 If so what is the quantum of the disposal consideration in respect of which reinvestment relief can apply?

 

1. REPRESENTATION OF THE PARTIES

 

The applicants were represented by Mr. Stephen Brandon QC, Mr. Oscar Kambona, Ms. Amanda Hardy, Ms. Reshma Shah, Mr. David Mpanga and Mr. Bruce Musinguzi.

 

The respondent was represented by Mr. Ali Ssekatawa, Mr. Peter Mulisa, Mr. Matthew Mugabi, Mr. Martin Muhanji, Ms. Syson Ainebabazi and Mr. Geoffrey Mucurezi.

 

1. SUMMARY OF EVIDENCE ADDUCED AT TRIAL

 

All the parties agreed that the applicants shall be allowed to file witness statements. Their witnesses would then be cross-examined by the respondent. The respondent opted to call its witnesses for examination in chief instead of filing witness statements.

 

The applicants’ first witness was Mr. Martin Graham, the General Counsel, of the Tullow Group (hereinafter called ‘Tullow’) which includes both applicants. In his statement, he stated that he dealt with the acquisition of Energy Africa Uganda Limited and Hardman Resources Limited by Tullow. He deponed that on their acquisition, Energy Africa Uganda Limited changed its name to TUL while Hardman changed to TUOP.

 

He further deponed about the signing of the PSAs between the GOU and the applicants. The PSAs gave exclusive rights to a party to explore for hydrocarbons in certain areas known as Exploration Areas (EAs). These areas included EA1, EA2 and EA3A. At the beginning of January 2010, TUL held 50% of the interests in EA1, EA2 and EA3A and TUOP held 50% of the interest in EA2. The other 50% interests in EA1 and EA3A were held by Heritage. On the 17^th January 2010, TUL exercised its pre-emption rights and acquired Heritage’s interests in EA1 and EA3A.

 

In February 2010, Heritage asked the GOU for consent to the transaction. The GOU gave consent subject to payment of tax. Heritage objected to the payment of tax. Later an arrangement was agreed upon where Heritage deposited the tax payable on an escrow account. The GOU and the applicant entered into a memorandum of understanding on the 15^th March 2011 where TUL paid US$ 313 million tax as agent for Heritage.

 

According to Mr. Graham, Tullow acquired Heritage’s interests in EA1 and EA3A with the express intention of selling them to third parties. It had intended to sell 50% of the interests in each of the PSA.  However the GOU would not give its consent to a sale to only one party. It eventually sold 66.67% of its interests in each of the PSAs to CNOOC and Total on 21^st February 2012, each purchaser taking 33.33% of the interests. He gave a background and history and the nature of oil exploration in Uganda in his statement, which we shall not repeat. He stated that the exploration areas had not yielded any income as yet.

 

Mr. Graham, in his statement, noted that under the PSAs the GOU gets its stake on oil in a number of ways which includes royalties, profit oil and 15% of the contractors’ share of profit oil under the state participation provisions.  If a project fails the GOU does not suffer any loss.  The costs recoverable are pooled together each year, and the balance is reduced by the value of cost oil received. Unrecovered costs are carried forward to subsequent years until full recovery is completed. He argued that this is not a tax relief or any kind of relief like indemnity. It is simply the recovery of expenditure incurred by one party. Such recovery does not prevent the oil company from deducting what it expended in tax computation.

 

Mr. Graham discussed the protection of the oil companies in the PSAs. He stated that “it is common for governments to provide certain incentives to encourage oil exploration. These incentives take the form of exemption or reliefs that reduce the company’s costs.” According to him, the EA2 PSA contained a clause providing that no tax would be payable in respect of a farm down of TUL’s interests in Article 23.5. Mr. Graham testified that Article 23.5 of the EA2 PSA provided that the assignment or transfer of an interest under the agreement would not be subject to any tax, fee or other impost or fee levied either on the assignor or the assignee. To him he was not sure whether Capital Gains Tax and transfer tax are the same. He stated that at the time the EA2 PSA was entered into, it was not certain that there were any hydrocarbon deposits in Uganda and so potential investor’s interest in the EA2 PSA was very low. He argued that Article 23.5 was advantageous to the GOU because it significantly increased the possibility of investment in Uganda. He argued that without any tax breaks it was unlikely that any companies would have invested in Uganda, especially where exploration involved a lot of monies. According to him, Article 23.5 of the EA2 PSA was certainly important to Tullow. It had incurred considerable expenditure. Tullow could not keep the whole of its interests in EA2, so a farmdown was inevitable. Mr. Graham testified that the applicants relied on Article 23.5 of the EA2 PSA when selling their interest as they wanted to benefit from the no tax on the farmdown of their interests.

 

Mr. Graham said that US$ 1.45 billion was paid by TUL for the acquisition of Heritage’s interests. The money was raised from shareholders. He said farming down was a way of the applicants financing exploration activities and development. He referred to exhibit A46, a letter to the Minster of Energy, where the applicant expressly stated that upon acquisition of the interest in Blocks 1 and 3A, the applicants would farm down at least 50% of the interests in all the Blocks to one or more partners acceptable to GOU. He stated that the applicants were forced to sell an extra 16.67% of their interests. There was pressure from the GOU for the applicants to break the monopoly in oil exploration. There was no official communication that the applicants should sell 66.67% of their interests. However there were several meetings with GOU officials at different levels where it was indicated that the applicants should retain a third of their interests.

 

 

Mr. Graham said he did not engage in drafting the PSA for the farmdown. The legal team did it. However as head of the legal team he took responsibility.  The tax department was working with him. Mr. Graham stated that he is not a tax expert. The applicants did not do a due diligence before they transacted with Hardman and others.

 

Mr. Graham said that the applicants sold first what was purchased from Heritage. The Heritage interest was the whole of the value that was presented in the PSA. They took over the costs incurred by Heritage. The monies the applicant used to pay the tax for Heritage came from Total and CNOOC.

 

The applicant’s second witness was Mr. Paul McDade, the Chief Operating Officer of the Tullow. He noted that the respondent raised assessments on the 18^th October 2010 in respect of the three blocks. However the farmdown had not taken place. It took place on the 27^th February 2012. At the beginning of January 2010 TUL held 50% interests in EA1, EA2 and EA3A and TUOP held the other 50% of EA2. The other 50% of EA1 and EA3A was held by Heritage.

 

Mr. McDade gave a background to the farmdown in his witness statement, which is as stated in the agreed facts. He added that since the discoveries in 2006 and 2007, the applicants planned to farmdown in order to meet the substantial costs needed for exploration. One of the functions of the farmdown was to assist financing their projected investments.

 

Mr. McDade further testified that the GOU indicated to the senior Tullow executives that a 50% farmdown would not be acceptable to it. It was GOU policy to avoid a monopoly situation in the Albertine Graben. Mr. Richard Inch emailed to him about a conversation he had with Mr. Kiiza, the Director of Economic Affairs, Ministry of Finance, Planning and Economic Development that the GOU would not allow a 50% split. The applicants changed their position of a 50:50 split to a 33:33:33 split as the former proposal would not be allowed. Mr. McDade argued that the disposal of 16.67% was therefore an involuntary disposal. He further testified that at the time of disposal Tullow was planning to reinvest considerable sums from the farmdown proceeds in assets of a like kind within one year from the farmdown.

 

In cross-examination, Mr. McDade said that the intention to sell 50% of its interest was not expressed in any form of board resolution. Mr. McDade reiterated his earlier position that Tullow wanted to sell at least 50% of its interests. There was no correspondence between GOU and Tullow that indicated that the latter wanted to sell 50% of its interest. He stated that there was a draft SPA which was on a basis of 50:50 made in February 2010. He did not clearly understand what a re-investment relief was.

 

In re-examination, Mr. McDade stated that the monies obtained from the sale were to be spent on the exploration activities, drilling, appraisal activities, testing of oils and associated activities or development studies. All the expenditures met prior to the farmdown were exploration and appraisals expenditures, drilling of wells, bridges, procuring of service studies, geological, etc.

 

The applicant’s third witness was Mr. Richard Inch, the Head of Tax for Tullow. The applicants are subsidiaries of the Tullow. He is a Chartered Accountant and a Chartered Tax Advisor and has held a number of senior tax positions. His duties involved the overall management of the group’s tax affairs.

 

He stated that following the acquisition of Heritage’s interests in EA1 and EA3A, Tullow agreed to sell a part thereof to Total and CNOOC. Tullow had intended to sell 50% of the interests in EA1, EA2, and EA3A. However before the GOU would grant the necessary consent, it required Tullow to sell a further 16.67% of the remaining interests. He stated that in a meeting of the 2^nd February 2010, with Mr. Lawrence Kiiza the Director of Economic Affairs, he was told that GOU was not going to allow a sale of only 50% of the PSA and wanted a single distinct operator for each PSA, with each taking 33.33% interest. Mr. Inch testified that there were no minutes for the meeting he had with Mr. Kiiza, It was a conversation. There was no official communication. 

 

He deponed that, on the 18^th October 2010, the respondent raised assessments on Tullow. The completion of the disposal took place on the 27^th February 2012. In response to the assessments, Tullow filed an objection on the 1^st December 2010.

 

Mr. Inch, in his statement, averred that before 2008, there was no specific taxation regime for oil companies in the ITA though the PSAs contained relevant tax provisions. In 2008, the Ministry of Finance introduced a specific code in relation to petroleum operations by the insertion in the Income Tax Act 1997 of a new Part IXA by the Income Tax (Amendment) Act 2008. The 2008 Amendment Act, which was published on the 30^th June 2008 had retrospective effect from 1^st July 1997. Part IXA under S. 89G (a) provides for taxation in cases of transfer of interests. The deponent felt that the said Act did not impact on Tullow, in particular the EA2 PSA, because it had obtained an exemption.

 

Mr. Inch testified that around the time the 2008 Amendment Act was passed, Tullow was in discussion with its banks regarding funding of its operations. A farmdown was an important part in its financing plans. It assumed that the farmdown proceeds would be received tax-free. In relation to the EA1 and EA3A PSAs, he thought that the new Part IXA in the ITA provided for exemptions in relation to the interests in the said PSAs.

 

Mr. Inch emphasized that Tullow did not anticipate any taxes. This was because the EA2 PSA was a legal and binding agreement. It had an exemption from capital gains tax in Article 23.5. Mr. Inch stated that: “the obligations under the PSAs were negotiated in good faith on the basis of the stability and certainty of the Uganda fiscal regime...” However, he stated that Mr. Kiiza told Tullow that there were views within the GOU that the EA2 exemption was not valid. Tullow was informed that the URA had in mind a tax liability of around US$ 470 million which indicated that the GOU did not accept that Article 23.5 of EA2 PSA gave an exemption.

 

Mr Inch argued that the sovereign state of the Republic of Uganda had the authority to enter such agreement and therefore could not collect tax. According to Mr. Inch, the terms of the PSA prevailed in case there was a conflict with the ITA.  Tullow had the right to expect GOU to keep its words as set out and agreed in Article 23.5 of the PSA. According to Mr. Inch, GOU has given exemptions to other companies, for example Bidco.

 

Mr. Inch also submitted that Tullow’s cost base was the Heritage gain subject only to any potential deduction in respect of excess costs. He stated in his statement that Tullow has no excess costs. Tullow paid the base price of US$ 1,350 million and a contingent consideration of US$ 100 million. Tullow also paid an additional US$ 13,937,116 in respect of the working capital at completion. Tullow paid a guarantee cost of US$ 46,061,058, stamp duty of US$ 14,500,0000 on acquisition and legal fees of US$ 1,079,077 giving to total incidental costs of US$ 61,140,135.

 

In cross examination, Mr. Inch testified that the ITA imposed capital gains tax subject to the provisions of the SPA. He also testified that the proceeds from the farmdown would be used for exploration, production and development.

 

Mr. Inch informed the Tribunal that Heritage and Tullow had indivisible interests. There was no way one could split and say what is for Tullow and what is for Heritage. Mr. Inch stated that there was no letter saying that Tullow was buying the Heritage interests specifically to sell. The intention was not expressed in any board resolution. However Mr. Inch said that was the common understanding of the senior management team.

 

He said that Blocks 1 and 3A were sold by Tullow to CNOOC and Total at a loss of US$ 175,577,251. He stated that there were additional payments that were made to Heritage and they could not pass them to the buyers. They incurred an economic cost of US$ 100 million contingent and guarantee fees to the bank which cost around US$ 46 million. He stated that Tullow sold 66.67% of its interests at US$ 2.9 billion but 50% of that were interests that formerly belonged to Heritage. They sold Heritage interests at US$ 1.45 billion at a loss. He said the answer would have been different for tax computation if they had considered the asset as undivided. He said the loss arose because Tullow expensed it with the cost of the asset acquired in accordance with international accounting standards. Legally Tullow sold Heritage interest first.

 

He testified that there was a difference between the first disposal by Heritage and the second disposal by Tullow in respect of computing the cost base and deductions. The distinction is that for an initial disposal, the cost base of the asset is the amount paid, to which is added incidental costs of the acquisition and in the case of a subsequent disposal the cost base is the first seller’s gain.

 

The respondent called two witnesses. The first witness was Mr. Ernest Tumwine Rubondo, the Commissioner Department of Petroleum Exploration and Production in the Ministry of Energy and Mineral Development in the GOU.  Mr. Ernest Rubondo gave a lengthy history of petroleum explorations in Uganda which he stated dates back as far as 1910, when oil seeps were reported. Oil explorations started but ended around 1940 as a result of the onset of the Second World War. In the 1980s efforts on oil exploration were restarted. A successful survey was done which identified 3 large deposit centres in the Graben.

 

To cut a long story short, in January 1997, the GOU licensed Heritage to explore oil in EA3A. In November 1997, the GOU signed an agreement with Hardman for EA2 which the latter surrendered in 1999 because oil prices had gone low. Heritage was joined by Energy Africa in 2000. In 2002, Heritage and Energy Africa drilled Turaco 1 where they encountered oil shoals. The companies also drilled Turaco 2 and 3 where they encountered hydro carbons in 2004. In 2004, Heritage and Energy Africa actually surrendered Area 3 and reapplied for it from the GOU. In July 2004, the companies acquired another licence in the Pakwach Basin. In 2006 oil was discovered.  

 

Mr. Rubondo testified that he was part of the GOU team that negotiated the EA1 PSA. GOU would do a due diligence on a company and if it was worth dealing with, it would send it a draft PSA. The parties would then agree on the terms. He testified that Article 23.5 was in the model PSA that was prepared in 1993. It was not negotiated by the parties. He said that the intention of GOU was that it did not want licensees to be encumbered with fees, imposts and taxes. The objective of the clause was to facilitate the licensees to bring on board partners to share risk without the need to pay fees and imposts like stamp duties and signature bonuses. He said clearly the clause was not meant to cover taxes on gains. Its purpose was to facilitate the sharing of risk and not to guide the taxation of a gain.

 

He further testified that TUL acquired Energy Africa in 2004. TUOP acquired Hardman in 2007. TUL had 50% interests in EA1 and EA2. TUL was together with Heritage in EA3 in a 50% each joint venture. TUL took over Heritage’s interests on 7^th April 2011 after it exercised it right of pre- emption. TUL acquired the rights of Heritage to develop and produce oil. He stated that the said interests in the agreements were indivisible.

 

On cross-examination, Mr. Rubondo reiterated his earlier position that Article 23.5 does not apply to farmdowns. He stated that the farmdown to CNOOC and Total was dependant on consent from GOU, more precisely the Ministry of Energy and Mineral Development.

 

The respondent’s second witness was Mr. Moses Mesach Kajubi, its Commissioner Domestic Taxes. The Domestic Tax Department is responsible for collecting all domestic taxes in Uganda inclusive of income taxes.

 

Sometime in October 2010, the department received the SPAs of Tullow, Total and CNOOC. The department studied the SPAs and realised that Tullow was selling its interests to Total and CNOOC. On the 18^th October 2010, the respondent issued assessments to Tullow. The assessments were issued because it was a one off transaction and it was of substantial value. The respondent revised the assessments on the applicant. A revised assessment was issued in February 2012 which was again revised in November 2012.  What changed between the earlier assessments was that the cost base changed from US$ 1.299 billion to US$ 1.3136871116 billion because Tullow paid an extra US$ 13.687 million dollars to Heritage. There was also new information that Tullow incurred more costs from US$ 57,000,000 to US$ 61,903,387. The effect of the changes was to reduce the total tax payable to US$ 467,271,974.

 

The respondent in computing taxes made some deductions. These included the signature bonus in respect of EA 1 and EA 3A. Excess costs were allowed. The recoverable costs that had been sold by Heritage Oil were subtracted. The incidental expenses incurred by Tullow of US$ 47 million were allowed. The net gain for TUL was computed at US$ 1,303,081,531 and the tax at 30% was US$ 390,924,460. For TUOP the net gain was computed at US$ 28,332,200 and taxed at 30% bringing the tax to US$ 84,999,660. The total tax payable was US$ 475,924,120.05. Tullow objected to the assessments of the said taxes on the 1^st December 2010. An objection decision was made on the 24^th February 2011.

 

The assessments did not remain the same. Costs of about US$ 10,586,638 were accepted. These costs were related to guarantee commitment fees and legal fees of US$ 457,397 dollars and stamp duty of US$ 14,500,000. The assessments were revised to US$ 387,748,468.65 for TUL and US$ 84,999,660 for TUOP bringing the total to US$ 472,748,128.65.

 

The respondent rejected the applicants’ objection to have no tax paid in relation to EA2 as a result of Article 23.5 of the PSA. Mr Kajubi argued that Article 23.5 of the EA2 PSA was not part of the ITA. The PSA was not an international agreement. Tullow is not an international organisation and the PSA was not ratified in accordance with the ratification of laws.  Mr. Kajubi also argued that the powers to levy tax in Uganda are vested in the Parliament. The said income was not exempted by Parliament. The Ministry of Energy could not take away the power of Parliament to grant exemptions. Mr. Kajubi argued that capital gains tax is not a transfer tax and therefore is not exempted by the ITA.

 

Mr. Kajubi argued that excess costs should be used in the computation of taxes.  Excess costs are relevant in subsequent disposals. Tullow argued that excess costs were nil. However the respondent argued that excess costs were US$ 150 million. According to Mr. Kajubi, excess costs reduce the cost base on the subsequent disposal. Mr. Kajubi argued that when a subsequent disposal is made, a taxpayer is only restricted to excess costs.

 

Mr. Kajubi testified that the recoverable costs incurred by the applicants were rejected as deductions. This is because they are available for recovery under the SPA. To allow them would give the taxpayer a double benefit.

 

As regards the issue of reinvestment relief, Mr. Kajubi stated that the respondent did not get any evidence of an involuntary disposal. In order for an involuntary disposal to take place it must be done against one’s will. Tullow was willing to sell its interests. There was no evidence to show that Tullow was forced to sell the extra 16.67% of its interest. According to Mr. Kajubi what was required to prove involuntary disposal would be a letter, a decree or something in writing. Secondly, the proceeds of an involuntary disposal should be reinvested in an asset of a like kind. This has to be done within one year of the disposal. He contended that the transaction was concluded in March 2012 and there is no evidence that there was reinvestment within one year from the date of disposal. Any expenses that would be brought to the attention of the respondent would be used to make an adjustment. Mr. Kajubi opined that the assets of a like kind should be an investment in an interest in another PSA..

 

Mr. Kajubi said the sale price for the interests in EA1 was US$ 775 million and on EA3 was US$ 575 million. These figures were picked from the SPAs. The cost base was US$ 746,152,777 for EA 1 and US$ 553, 597,222 for EA2.He also argued that the economic loss claimed by the applicants was a creation and not real. The purported economic loss arose from Tullow claiming that what were sold first were Heritage’s interests. Out of the 66.67% interest sold, 50% was what was purchased from Heritage. Therefore the cost base for that should be accepted as a cost in the computation of the loss. The loss was a result of the ‘last in first out’ (LIFO) in the allocation of costs approach. If the ‘first in first out’ (FIFO) approach was used there would be no loss. The gain for FIFO approach is about 230 million dollars.

 

Mr. Kajubi stated that ‘excess costs’ is the difference between the costs that are available for recovery from the first person who sold, minus anything that is recovered. They apply to a subsequent sale. Heritage had recoverable costs of US$ 150 million. He said that excess costs are deducted from cost oil. He defined cost oil to mean a contractor’s entitlement to production as cost recovery under a PSA. He said that a company obtains cost oil at the commencement of commercial production. There has not been any commencement of commercial production and recovery of costs. None of the companies involved, Heritage, Total CNOOC and Hardman have recovered any expenditure.

 

Mr. Kajubi told the Tribunal that stamp duty was paid in the acquisition of interests from Tullow to CNOCC and Total. He said there was no exemption for stamp duty. In order to get an exemption the Minister of Finance would have to issue a statutory instrument to that effect as per the powers delegated to him by Parliament. He stated that no tax exemption is valid unless there is a specific provision in the ITA. Tax holidays and tax exemptions require a statutory instrument issued by Parliament. He said the respondent does not grant exemptions, it implements. It issues certificates but the exemptions are granted by Parliament.

 

Mr. Kajubi said the right to recover costs is one of the rights disposed of under the SPA as an assignable interest. He stated that Tullow received consideration for the transfer of the said right to CNOOC and Total. To obtain a benefit from such a relief after disposing of the same interest would amount to double dipping.

 

5.    SUMMARY OF THE PARTIES’ MAIN ARGUMENTS 

  

On issue 1.1, the applicants submitted that the completion of the sale and purchase between the applicants, CNOOC and Total occurred on the 21^st February 2012 when the various conditions were met and the purchase price paid. As a result thereof the applicants transferred parts of their interests in the PSAs to CNOOC and Total on that date. The applicants contended that such disposals were governed by S. 89G of the ITA. Hence they attracted capital gains tax.

 

The applicants submitted that EA2 PSA Article 23.5 contained an exemption from taxes. It not only covered income tax but all other fees or imposts levied on an assignor. Such a wide exemption cannot be said to exclude a charge to tax under the ITA. The income tax charge imposed by the Income Tax Act is clearly a charge to tax. According to them, Article 23.5 of the Agreement was wide and clearly covered income tax on capital gains accruing on assignment or transfer. The applicants argued that when a person passes an interest in an agreement to another contractor, he must assign or transfer that interest. The applicants cited Black’s Law Dictionary which defines assignment as an “act by which one person transfers to another, or causes to vest in that other, the whole of the right, interest, or property which he has in any realty or personality...” According to them, Article 23.5 of the Agreement was wide and clearly covered income tax on capital gains accruing on assignment or transfer.

 

On issue 1.2, the applicants argued that any minister irrespective of whether he or she is the Minister of Finance could enter an agreement containing a term as found in Article 23.5. They contended that the Minister as an agent of the GOU had authority to sign the PSA on its behalf in respect of each provision. The applicants contended that RW1, Mr. Rubondo, admitted that when an agreement was reached the Ministry would send it to the cabinet before signing.

 

The applicants submitted that the Minster validly entered into the agreement on the basis of powers conferred under the Petroleum and Energy Production Act 1985 (PEPA). The applicants argued that under S. 2 of the PEPA, the GOU may enter into an agreement with any person in respect of, inter alia, the grant of a licence, etc and any matters incidental to or connected with the foregoing. The applicants argued that S. 2 applied to Article 23.5 of the PSA and granted necessary powers to the Minister to enter into the agreement where an exemption was granted. This was because Article 23.5 was incidental and connected with the foregoing, that is, the granting of a licence. The applicants cited the case of Scottish Widows plc V RCC [2010] STC 2133 where the court emphasised that “...the phrase ‘in connection with’ generally merits a wide interpretation...” it was their submission that “connected with” requires a very wide interpretation, akin to “having to do with” in PEPA, S.2. The applicants submitted that the fact that there may be specific exemptions in the ITA governed by particular rules does not mean that the GOU cannot grant a tax exemption under another Act.

 

The applicants argued that though the ITA was enacted after the PEPA, there is nothing in the ITA that could be said to amend or repeal the PEPA. A later law can only implicitly amend an earlier law where two provisions in question cannot co-exist. S. 2 of the PEPA covers a number of possible matters, most of which have nothing to do with tax. Thus the taxing legislation cannot possibly be said to repeal implicitly a provision with wider import. S. 2 of the Act does not grant an exemption from tax, it empowers the Minister to grant such an exemption. It empowers the GOU to agree to refrain from enforcing the ITA in certain circumstances which are “incidental to or connected with” the matters in the PEPA.

 

The applicants submitted that there are other authorities given to the GOU acting through the Minister to enter the EA2 PSA, including Article 23.5. These authorities include pre-written constitution powers preserved by the Constitution. This is evidenced in Article 274 of the Constitution. The applicants contended that the existing common law or prerogative powers vested in the President and the rest of the executive continue to apply, including the power to waive or vary payment of tax which existed prior to the enactment of the Constitution. Therefore the pre-written constitution powers are one of the sources of the Minster’s powers to enter into Article 23.5.

 

The applicants contended that under the Constitution of Uganda, the Minster had powers to enter the PSA Article 23.5. Objective I of the Constitution required all organs and agencies of the State to apply the objectives and principles in the Constitution in interpreting any other law or implementing any policy decisions. These objectives include the right to development (objective IX) and stimulation of industrial development by adoption of appropriate policies (objective XI(ii)).  The terms of the PEPA are worded to support the honouring of obligations such as Article 23.5 as it encompassed policies aimed at stimulating industry and encouraging private initiative for the benefit of Uganda.

 

The applicants argued that Article 2 of the Constitution provides for the supremacy of the Constitution. The applicants argued that the Constitution does not make express provisions of granting tax exemptions or not. There is also no express provision that the general powers of the Constitution shall prevail over statute law where the two are inconsistent. The applicants argued that the vesting of executive power in the Constitution in the President gives him very wide powers. There is no specific provision preventing the President from granting a tax exemption in the Constitution. The applicants submitted that Article 11(2) of the Constitution also confers wide powers on the cabinet. This is the source of the Minster’s powers to enter into Article 23.5. Article 23.5 does not seek to amend the ITA.

 

In respect of issue 1.3, the applicants requested the Tribunal not to make any ruling on the application of international law to the present dispute. In short, the applicants abandoned the said issue.

 

As regards issue1.4, the applicants contended that the respondent was an agent of GOU. While its actions bind GOU, it is also bound by GOU. The Uganda Revenue Authority Act 1991 (URAA) established the respondent as a central body for the assessment and collection of specified revenue and to administer and enforce the laws relating to such revenue. Under the said Act, the Authority is an agency of the GOU. The applicants cited Heritage Oil and Gas Limited v URA Civil Appeal 14 of 2011 where the court said that URA is not autonomous of GOU. URA as a statutory agent is part and parcel of GOU. It cannot therefore be seen to disassociate itself from the PSA. Thus the PSAs are agreements entered into by the GOU but to which the respondent is also a party. The applicants argued that the effect of the decision in Heritage is that the GOU cannot simply ignore the EA2 PSA Article 23.5. The Minster signed on behalf of the GOU. The respondent as an agent of GOU clearly cannot ignore a legally binding obligation of the GOU, its principal.

 

The applicants argued the Tribunal should enforce Article 23.5 exercising the jurisdiction conferred on it by the TAT Act. The applicants contended that the Tribunal’s powers are wide. They include the powers of it to “stand in the shoes” of the decision maker and exercise all the powers he or she had at the time the decision was made. The Tribunal can make a new decision in substitution of the original one.

 

Issues 1.5 and 1.6 dealt with the doctrines of estoppel and of legitimate expectation respectively. The applicants contended that estoppel refers to circumstances in which by the operation of law an individual or body is prevented from behaving in a particular manner. References to estoppel include reference to legitimate expectation. Legitimate expectation applies to prevent the GOU from ignoring its obligations under the EA2 PSA Article 23.5. Similarly, the principle of pacta sunt servanda may also operate to prevent unfairness.

 

The applicants also relied on “legitimate expectation”, a principle distinct from estoppel. The applicants argued that since estoppel cannot apply to the GOU, the references to estoppel in the objection refer to GOU being estopped by other principles of fairness particularly legitimate expectation and pacta sunt servanda. The applicants contended that legitimate expectation can and does apply to prevent the GOU from ignoring its obligations under the EA2 PSA Article 23.5. Similarly, the principle of pacta sunt servanda applies.

 

The applicants cited the case of Council of Civil Services Union v Minister for Civil Service [1985] AC 374, where Lord Fraser said:

“A legitimate expectation may arise either from an express promise given on behalf of a public authority or from the existence of a regular practice which the claimant can reasonably expect to continue...”

The applicants argued that its legitimate expectation is clearly within the terms as defined. The applicants submitted that the principle of legitimate expectation applies so as to estop an agency of the state going back on its representation. The applicant submitted that the GOU through the Minister entered into the PSA. The GOU has bound the revenue authority, the URA, as its agent, to honour its agreement. The Tribunal should ensure that the respondent does this.

 

The applicants relied on the evidence of their witnesses to rely on the application of the principle of legitimate expectation. AW1 Mr. Martin Graham testified that: “Tax reliefs or exemptions are part of ensuring that the entering into a PSA is economically viable. .... It is common for governments to provide certain incentives to encourage oil production. ...” They concluded that Article 23.5 gave them the “confidence to proceed on the basis that there would be no tax.”  AW3, Mr. Richard Inch, stated that in relation to EA2, there was “no concern as to the taxation position because of the exemption for capital gains tax in respect of a farmdown in Article 23.5...”

 

The applicants also argued that the use of “estopped” by them is not the use of the technical term “estoppel”. They argued that the term “estopped” has a wider meaning. Black’s Law Dictionary defines “estopped” to mean “to prevent, stop or bar something from happening.” The use of legitimate expectation is covered by estopped. The applicants cited the case of R v IRC, ex p MFK Underwriting Agencies Ltd. [1989] STC 873 where Bingham LJ linked the concept of legitimate expectation and estoppel in saying:

“If in private law a body would be ... estopped from so acting a public authority should generally be in no better position. The doctrine of legitimate expectation is rooted in fairness.”

Therefore the respondent as an agent of the GOU, which had agreed that there would be no tax to be charged, should be estopped from acting unfairly by charging tax.

 

The applicants argued that while estoppel is a private law remedy, legitimate expectation is a public law remedy. While the doctrine of estoppel may not apply to the GOU or the respondent, this does not mean that public bodies have a “free rein” to behave in a manner which is unfair and prejudicial to the rights of the individual. The applicants contended that the doctrine of legitimate expectation was also confirmed in the decision of the House of Lords in East Sussex County Council; ex parte Reprotech (Pebsham) Ltd. [2002] 4 All ER 58, where Lord Hoffman stated at paragraph 35:

“... It seems to me that in this area, public law has already absorbed whatever is useful from the moral values which underlie the private law concept of estoppel and the time has come for it to stand upon its own feet.”

The applicants submitted that legitimate expectation can apply to restrict the activities of an agency of a state, including the discharge of its functions under a statute. The applicants cited the case of Preston v IRC [1985] AC 835 where the Court saw no reason why it should not review:

“..... a decision taken by the commissioners [of Inland Revenue] if that decision is unfair to the tax payer because the conduct of the commissioners is equivalent to a breach of contract...”

In R v IRC, ex p MFK Underwriting Agencies Ltd [1989] STC 873 the court noted:

“...If a public authority so conducts itself as to create a legitimate expectation that a certain course will be followed it would often be unfair if the authority were permitted to follow a different course to the detriment of the one who entertained the expectation...”

The applicants therefore argued that where the revenue authority so conducted itself to create a legitimate expectation that the state will not charge tax in particular circumstances, tax shall not be charged. If the taxpayer has a legitimate expectation the state must keep its word. Hence if a party were to show that the representations were made to it by a state or an agency of the state and it has legitimate expectation then the state would be bound by those representations.

 

The applicants argued that the development of legitimate expectation can be seen in a decision of the High Court of Kenya in Republic and Others v Attorney General [2006] 2 EA 265 where the court stated that:

“The principle which justifies the importance of procedural protection has come to be known as legitimate expectation. Such an expectation arises where a person responsible for taking a decision has induced in someone who may be affected by the decision a reasonable expectation that he will receive or retain a benefit....”

The applicants argued that the doctrine of legitimate expectation has also been applied in a number of other cases in Kenya. These include: Republic v Minister for Local Government and another ex parte Paul Mugeithi Joel [2008] KLR Miscellaneous Civil Application 480 of 2008, Republic and others v Attorney General and another [2006] 2 EA 265. The applicants, therefore, argued the Tribunal should accept that the doctrine of legitimate expectation forms part of the law of Uganda. They contended that the principle was applied in the High Court of Uganda in the case of Kato v Njuki [2009] UGHC 23.

 

The applicants also relied on the doctrine of pacta sunt servanda, which requires those entering into contracts to honour their obligations. The applicant contended that respondent as agent of the GOU is not entitled to collect tax from the applicants in contravention of Article 23.5 of the EA2 PSA.

 

On issue 2, the applicants contended that they sold 66.67% of the interests they held in the blocks. Of the 66.67% interest, 50% interest was what they acquired from Heritage, 16.67% was their original interest. The applicants contended that they purchased the Heritage interests exercising their pre-emption rights for the purpose of selling them and to facilitate the development of the areas. The applicants objected to the respondent’s argument that the interests they sold were indivisible. The applicants argued that there were no accounting principles which discourage transactions carried out in the way the applicants sold their interests to CNOOC and Total i.e. by selling all of the Heritage interests first and a small proportion of the original interests.

 

The applicants argued that the respondent’s alternative proposal of ‘first in first out’ (FIFO) model was aimed at yielding the greatest amount of tax which overrides the clear provisions of the SPAs. The applicants cited the case of Stanton v Drayton [1983] 1 AC 501 where the court noted that the consideration in any particular case must be determined by reference to the contract which the parties concerned concluded.

 

In respect of computation of capital gains, the applicants contended that this is determined by the rules set out in Part IXA of the ITA. The applicants submitted that S. 89B provided for inconsistencies. Where there is an inconsistency between Part IXA and other parts of the ITA, the former prevails. The applicants argued that S. 22 of the ITA is not applicable by virtue of S. 89B (2). S. 89C – 89F sets out the rules dealing with allowable deductions against the income, which is relevant when commercial production starts.

 

The applicants objected to the application of S. 22(c) of the ITA which provides for “recoverable costs”. They argued that this prevents the applicants being allowed the costs of expenditure as their cost base in the computation of a chargeable gain. The applicant argued that the respondent’s claim that the contractors obtained recovery of costs under an indemnity or agreement is unfounded. There is no such indemnity or agreement, it is merely to apportion turnover in accordance with what each partner has spend. 

 

The applicants argued that S. 22 does not apply to a first disposal. They contended that S. 22 is not incorporated into Part IXA, in particular in S. 89(c) or Part VI. S. 22 is within Part IV, ‘Chargeable Income’. S. 22 is only concerned with income, not gains. The applicants contended that there is nothing that stops allowable expenditure forming part of the cost base on the original interest. The applicants submitted that Sections 89C, 89G(c), 89F, the 8^th Schedule and S. 52 contain the provisions of the taxation of disposals of interests in a petroleum agreement. S. 22 is not applicable as it is inconsistent with Part IXA. The applicants see no tenable reason why incidental expenditure incurred in improving or altering the assets under the PSA should not be deducted under S. 52(6).

 

 In reference to the double dip point raised in the objection decision by the respondent, the applicants argued it can only have effect in two circumstances. The first in respect of the possible future use of the carried forward potential deductions against cost oil. The second in respect of the potential use by a transferee of the deduction against cost oil.

 

The applicants submitted that S. 89G, which is headed “Transfer of interests in a Petroleum Agreement”, sets out the rules for dealing with the allowable deductions upon the transfer of an interest. The applicants contended that there are separate charging codes for the original interests (First disposals) and subsequent disposals.

 

The applicants submitted that S. 89G(c) is used for determining the cost base where there is an original transfer of interest. The cost base will be determined in accordance with Part VI of the Act. Part VI comprises Section 49 – 54 of the ITA.  In Part VI, the principal rules for the computation of the tax base are set out in S. 52 of the ITA. The applicants submitted where there is a first disposal the rules fix the cost base by taking into consideration what the taxpayer expended on the interest. The applicants contended that the transfer of the original interests and the EA2 interests were subject to the regime in S. 89G(c) of the ITA. The applicants contended that the cost base of the original EA1 and EA3A interests and the EA2 interests included incidental expenditure incurred to purchase, produce, construct or improve these interests. The incidental expenses that were communicated by the applicants to the respondent were 47 million 

 

Part IXA contains separate charging rules for subsequent transfers of interests in petroleum agreements in S. 89G(d). Where there is a subsequent disposal the rules allow a deemed cost base, which is the gains made by the person the taxpayer bought from, then it is reduced by excess costs. The disposal of the Heritage interests to CNOOC and Total was a “subsequent disposal.” The transfer of Heritage interests was subject to the regime in S. 89G(d) for subsequent disposals. The applicants are the “transferee contractors” and Heritage is the “Transferor Contractor”. In determining the applicant’s cost base for the gain in the disposal to Total and CNOOC it is Heritage’s gain which was computed at US$ 1,450,000,000 as held in Heritage Oil and Gas Limited v URA Applications 26 and 28 of 2010. The transferor contractor’s gain is deemed to be the transferee contractor’s cost base.

 

The applicants submitted that deductions in income computation is dealt with by S. 89C of the ITA. The applicants further submitted that S. 89C allows expenditure on petroleum operations as a deduction in respect of income only against cost oil, if there is none, the expenditure is carried forward. Cost oil is defined in S. 89A. S. 89C(1) provides the rules for deductions allowable against income by allowing them only against cost oil. Thus the income deductions are given against cost oil only from the year in which commercial production commences, which has not started. As the applicants have no cost oil, the applicants have not deducted anything. Therefore in respect of the original interests and EA2 interests there was no deduction allowed.

 

The applicants contended that excess costs are not defined. However reference to the term may be obtained from S. 89C(2) of the ITA. Excess costs under S. 89G(d)(i) are the excess of the total deductions given in relation to petroleum operations less the cost oil for the year of income. The applicants contended that excess costs cannot arise as commercial production has not started. There are no excess costs to be taken into account and none to deduct from the cost base under S. 89G(d)(i).

 

The third issue was in respect to the applicants’ entitlement to reinvestment relief. S. 54 of the ITA provides for involuntary disposals and the entitlement to reinvestment relief. The applicants had to show that the disposal was involuntary and the proceeds are to be reinvested in assets of a like kind within the specified period.

 

The applicants farmed down an aggregate of 66.67% of their interests. The applicants argued that they intended to dispose of 50% of their interests. They needed GOU’s approval for the sale. The GOU wanted three equal partners to invest in the Lake Albert Basin. Since the applicants needed that GOU’s consent to proceed with the sale, they had no choice but to dispose 66.67% of their interests. The disposal of the extra 16.67% of the interests was not made voluntarily.

 

The applicants cited the authorities of Building Society v Commissioners of Inland Revenue 65 TC 265 and URA V Bank of Baroda HCT-00-CC-CA-05-2005, which broadly interpreted and discussed “involuntary” disposal. The applicants referred to the evidence of AW2, Mr. Paul McDade, who submitted at length the applicants’ desire to dispose of 50% of their interest. The applicants submitted that investment in assets/rights which are dealt with under the PSAs constitutes an investment in assets of a like kind. The applicants also submitted that they had incurred US$ 164,721 as reinvestment relief for the period of March 2012 to February 2013. However, the applicants also contended that, since the hearing before the Tribunal occurred before the one year period expired evidence of their expenditure on assets of a like kind would not be given.

 

Having discussed the powers and jurisdiction of the Tribunal, the applicants prayed that the assessments and the objection decision of the respondent be set aside. They also prayed that the Tribunal finds that Article 23.5 of the PSA is valid under the laws of Uganda and therefore they are entitled to exemption from payment of capital gains tax. They also prayed that all the costs incurred by the applicants, including exploration costs be allowable under S. 52 of the ITA.

They prayed that the Tribunal finds that there is no restriction to be made for excess costs for purposes of S. 89(G)(d) of the ITA. They also prayed that the Tribunal finds that the applicants are entitled to reinvestment relief to a tune of 16.67% interests in EAs 1, 2 and 3A which is the sum of US$ 164,721 so expended for purposes of reinvestment. The applicants in short prayed that the Tribunal makes new assessments of nil liability on each of the applicants. In the event of such, they prayed that the 30% deposit by them on filing the application be refunded to them.

 

In its reply, the respondent submitted that this matter is an attempt by the applicants to avoid paying income tax on an enormous gain resulting from the largest transaction in the history of Uganda, the sale of interests worth US$ 2.9 billion to Total and CNOOC. It argued that this is through the inappropriate manipulation of figures and distortion of the Uganda tax law by the applicants. 

 

On Issue 1.1, the respondent submitted that Article 23.5 of the EA2 PSA deals with what is referred to as transfer taxes which are distinct from taxes on income or gains resulting from transfers and is therefore irrelevant to the taxability of capital gains. The respondent argued that income or gains tax applies only to the extent that income of gain is actually realised whereas a transfer tax is charged on a transfer whether a gain or loss is realised and irrespective of whether consideration is paid for the transfer. The respondent argued that the language of Article 23.5 is concerned only with taxes that have “assignment or transfer” as the base of the tax. The respondent gave examples of transfer tax exemptions. It also referred to provisions of other countries - Angola and Equatorial Guinea, similar to Article 23.5 of the EA2 PSA.

 

The respondent submitted that provisions purporting to provide exemptions from tax must be narrowly construed. The respondent cited the authorities of Babibasssa v Commissioner General Uganda Revenue Authority [2013] UGCOMMC 21, Helvering v Northwest Steel Rolling Mills, Inc. Supreme Court (United States), 311 U.S. 46, Commissioner of Internal Revenue v Jacobson, Supreme Court (United States), 336, U.S. 28, Mayo Foundation for Medical Education & Research et. al. v United States, Supreme Court (United States), 131 S. Ct. 704, Edward Maughan (Surveyor of Taxes)  v The General Trustees of the Free Church of Scotland, Court of Session (Scotland), (1893) 20R. 759.

 

The respondent referred to the testimony of Mr. Ernest Rubondo, and Mr. Moses Kajubi, who supported the position that Article 23.5 of the EA2 PSA did not confer a tax exemption. The respondent argued that there is no evidence on record that contradicted this testimony.

 

The respondent also referred to the 2010 SPA which was signed by the applicants and Heritage. The said SPA defined transfer tax to mean “stamp duty payable under the laws of the Republic of Uganda”. Non- transfer Taxes were defined to mean “any taxes other than Transfer Taxes.” Under Clause 7.1 of the Agreement, all transfer taxes were to be borne by the buyer. Under Clause 7.2 any Non-Transfer tax including any capital gains tax shall be borne by the seller. The SPAs executed between the applicants, CNOOC and Total maintained the clear distinction between transfer taxes which was to be paid by the buyer and capital gains tax by the seller.

 

As regards transfer tax, the respondent cited J. Rogers-Glabush, IBFD International Tax Glossary 6^th Rev. ed., IBFD 2009 which perceives transfer tax as a “general term to refer to a tax levied on the transfer of goods and rights e.g. purchase and/or sale of securities and immovable property...”  It also cited Black’s Law Dictionary 9^th ed. 2009, 1597 which defines transfer tax as: “a tax imposed on the transfer of property, exp. by will, inheritance, or gift”, while West’s Encyclopaedia of American Law 2^nd ed. 2008, 79 defines it as “a charge imposed by the government upon the passing of title to real property or a valuable interest in such property.” The respondent contended that under the OECD, taxes on income, profits and capital gains are separated from taxes imposed on other bases including taxes on financial and capital transactions. The respondent contended that transfer tax is a type of “indirect tax” while income or gains tax constitute “direct taxes”.

 

The respondent submitted that in the US, there have been attempts to distinguish between transfer taxes such as stamp duty and property transfer taxes, and taxes imposed on gains resulting from a transfer. The respondent cited that authorities of S&M Enterprises v the United States, Court of Appeals for the Federal Circuit (United States), 199 F.3d 1317 where the court stated that if the tax is based solely on a gain, and not on the size of the transfer, it is not a transfer tax. The respondent also cited the case of 995 Fifth Avenue Associates v New York States Department of Taxation and Finance Court of Appeals for the Second Circuit (United States), 963 F, 2d 503 where the court emphasised that if the transaction yields no gain, there is no tax due. The nature of gains tax is different from stamp taxes and documentary transfer taxes.

 

The respondent also cited cases that have been addressed in UK courts. In Carreras Group Limited v Stamp Commissioner, Privy Council of the United Kingdom [2004] S.T.C 1377 the court pointed out that transfer tax is an ad valorem on the consideration for the property transferred, whereas the capital gains tax is a tax on capital gains.

 

The respondent objected to the applicants’ reference of the words “any tax” in Article 23.5 to have a wide coverage. The applicants had leaped to the conclusion that any tax clearly covers income tax on a capital gain accruing on an assignment or transfer. The respondent argued that this was a result of confusion in the applicants between the nature and the base of the charge.  

                                              

The respondent argued that Article 23.5 would be manifestly unlawful under Uganda law if the applicants’ interpretation of it as an exemption is accepted. The respondent submitted that under the Constitution of Uganda a tax may be imposed through a law passed by Parliament. Likewise a tax can only be varied if a law confers such power on the person or authority purporting to grant the waiver. The respondent cited Articles 79, 99 and 152 of the Constitution of Uganda. The respondent contended that the said provisions make it clear that the executive does not have the capacity to waive the law. The respondent cited that authorities of the Heritage case, K.M. Enterprises and others v Uganda Revenue Authority HCCS No. 599 of 2001 and Kampala Nissan Uganda Limited v Uganda Revenue Authority Civil Appeal No. 7 of 2009 to support its arguments.

 

The respondent submitted that discretionary tax exemptions are no longer allowed under the ITA after July 1997. Exemptions are now statutorily provided. The ITA amended the 1974 Income Tax Decree and the 1991 Investment Code Act. The respondent contended that through the adoption of the 1995 Constitution and the ITA, Uganda eliminated discretionary tax exemptions which were replaced with statutorily provided ones.

 

The respondent contended that the applicants’ argument that the 1993 PSA aimed at bringing companies into high risk investment involving enormous sums of money is not correct. When the 1993 PSA is compared to the 2001 PSA one can conclude that income tax exemptions are unlawful. It shows that Article 23.5 only excluded taxes and fees imposed on the transfer and not taxes on income resulting from a transfer. The respondent further contended that at the time Article 10 of the 1993 PSA was prepared, discretionary tax exemptions were lawful. After 1993 the GOU took a series of policy reforms which eliminated discretionary exemptions. The respondent contended that Article 11 of the EA2 PSA provided for all central taxes to be paid in accordance with the law.

 

The respondent submitted that the applicants’ argument that the Minister could grant an exemption under S.3 of PEPA is defective. The respondent averred that the term “connected with” must be interpreted in the context of the phrase “incidental to or connected with the foregoing.” The respondent cited the authority of Scottish Widow Plc v RCC (supra) already cited by the applicants. It contended that thus “connected with” must be read as part of the phrase “incidental to or connected with.”

 

The respondent also contended that the applicants’ argument ignores that the ITA is a specific statute governing income tax in Uganda and was adopted after the PEPA to consolidate and amend the law relating to income tax. It also contended that the ITA does not need to repeal or amend S. 3(e) of the PEPA. The respondent argued that the minister cannot have unbounded powers under S. 3 of the PEPA as it may have startling results. The respondent referred to an admission by the applicant’s own witness Mr. Inch, the Head of Tax that “the constitution is clear that an increase in tax is by an Act of Parliament”. Hence S. 3 of the PEPA does not confer power under Article 152 of the Constitution on a minister to waive or vary a tax.

 

The respondent submitted that the applicants’ contention that the Minister was authorised to grant an income tax exemption on the basis of Article 274 of the Constitution was unfounded. Article 274 does not provide for the preservation of existing powers. It only provides that existing powers must be modified to bring them in conformity with the Constitution. The respondent cited the authorities of Hon. Sam Kuteesa and others v Attorney General Constitutional Petition No. 46 of 2011 and Attorney General v Osotraco Ltd Civil Appeal 32 of 2002, to support its argument. The respondent submitted that the applicants do not explain the basis of their assertion that “pre-written constitution powers include a power to grant exemption from tax.”

 

The respondent asserted that Uganda law embraces the law that there can be no estoppel against a statute. If a contractual agreement is ultra vires the agreement is null, void and unenforceable.  The respondent cited the authorities of Major General David Tinyefuza v Attorney General Constitutional Petition No. 1 of 1996, KM Enterprises Ltd and others v Uganda Revenue Authority [2008] UGCommC 21, Heritage Oil & Gas Limited v URA Civil Appeal 14 of 2011, Pride Exporters Ltd v URA HCCS 503 of 2006, URA v Golden Leaves & Resorts Ltd and Apollo Hotel Corporation Ltd. MA 0783/ 2007, URA v Bwama Exporters Limited Civil Appeal 6 of 2003, Kampala Nissan Uganda Ltd. v URA Civil Appeal 7 of 2009.

 

The respondent submitted that the applicants’ arguments that the doctrine of estoppel should be restricted by that of legitimate expectation should not be taken seriously. The notion that the terms of a statute may be waived by an agreement that gives rise to a legitimate expectation is contrary to the rule of estoppel against a statute. The respondent argued that the applicants’ citation of the case of Kato v Njoki (supra) was frivolous as the application of the doctrine of legitimate expectation was remote.

 

The respondent submitted that the doctrine of legitimate expectation cannot apply to ultra vires acts. The respondent cited the case of Re: Watson’s Application for Leave to Appeal for Judicial Review (also known as Dollingstown Football Club v The Irish Football Association) [2011] NIQB 66 where the court stated that: “It is trite law that an expectation grounded upon an ultra vires representation cannot be legitimate.”  In Rowland v Environment Agency [2005] Ch.1 the Court of Appeal stated that “English domestic law does not allow the individual to retain the benefit which is the subject of the legitimate expectation, however strong, if creating or maintaining that benefit is beyond the power of that public body.” The respondent also cited the authority of Al Fayed and others v Advocate General for Scotland 2004 S.T.C 1703 where the court affirmed that an ultra vires agreement cannot give rise to a legitimate expectation. Other cases cited by the respondent included Wilkinson v Inland Revenue [2005] 1 W.l.R. 1718, R v North and East Devon Health Authority ex parte Coughlan [2001] Q.B, 213, R v Inland Revenue Commissioners, ex parte MFK Underwriting Agents Ltd [1989] S.T.C 873, R (on the application of Corkteck Ltd.) v Revenue and Customs Commissioners [2009] S.T.C. 681, R v East Sussex CC ex parte Reptrotech [2002] 4 All E.R.58, Republic and others v Attorney General [2006] 2 EA 265, Republic v Minister for Local Government & Another, ex parte Paul Mugethi Joel [2008] eKLR 6, Republic v National Environment Management Authority ex-parte Sound Equipment Ltd [2010] eKLR 8, Republic v The Disciplinary Committee & another Ex-parte Prof. Paul Musii Wambua [2013] eKLr 5. The respondent argued that most of the above cases were cited by the applicants who distorted their interpretations to suit their case.

 

The respondent argued that the applicants’ invocation of the international law principle of pacta sunt servanda (sanctity of contract) provides no support that the principle overrides the ultra vires principle. The respondent contends that the applicants abandoned their arguments based on international law.

 

On issue 2, the respondent submitted that TUL purchased a 50% undivided interest in the licences and agreements in relation to EA1 and EA3A from Heritage. It therefore obtained 100% ownership interests in EA1 and EA 3A. TUL and TUOP owned 50% undivided interests in EA2. After a sale to CNOOC and Total the holdings were as follows: In EA1 TUL, Total and CNOOC had 33.33% interests each; in EA2 TUOP, Total and CNOOC had 33.33% interests each and In EA3A TUL, Total and CNOOC had 33.33% interests each.

 

After receiving the SPAs, the respondent raised assessments in October 2010. The applicants objected to the assessments on various grounds. In particular that they had incurred more incidental costs. Following a review of the applicants’ objections, the respondent issued another objection decision and increased the incidental costs and disallowed other items. The respondent received further information from the applicants and increased the allowed incidental costs to US$ 61,903,387 which resulted in a tax liability of US$ 467,271,974. The respondent communicated the current assessments to the applicants on 2^nd November 2012. The applicants paid the 30% deposit of the tax before filing the application leaving a balance of US$ 325,447,536/=.

 

The respondent determined that the applicants had a taxable gain of US$ 1,113,332,200 from the sale of the EA2 interests, a taxable gain of US$ 449,831,550 for their sale of the 50% undivided interests in EA1 and EA3A (the “original interests”) and a loss of US$ 25,590,503 from the sale of a portion of their 50% undivided interests in EA1 and EA3A (the “Heritage Interests) for a total taxable gain of US$ 1, 557,573,247.

 

In calculating the applicants’ gains, the respondent disallowed pre-existing petroleum operations costs of US$ 320,545,819 from being included in the applicants’ cost base because such expenses were deductible against cost oil pursuant to S. 89C of the ITA. The respondent also disallowed a deduction for interest expense of US$ 113, 429,096 under the thin capitalisation rules under S. 89 of the ITA, which it contended was not in dispute. The respondent also disallowed the applicants from using a loss of US$ 20,987,930 on EA3A to reduce their gain on the sale of their EA3A interests because such loss related to a separate contract area, EA3, and was only available to offset cost oil from the area under S. 89C of the ITA, which is not in dispute. The respondent also disallowed the applicants’ claim that they are entitled to US$ 164,721,000 as reinvestment relief under S. 54(1) (c) of the ITA.

 

The respondent submitted that where a contractor as an original owner of interests disposes of them, S. 89G(c) is applicable. It provides that the cost base for calculating any capital gain or loss is determined under Part VI of the ITA. The general rules for the calculation of capital gains under Part VI are contained in S. 52 of the ITA. More specific rules for the treatment of expenditures incurred in relation to petroleum operations are set forth in S. 89C of the ITA. S. 89C (1) provides that the amounts deductible in relation to petroleum operations are allowed only as a deduction against cost oil. The respondent submitted that under S. 89C of the ITA a contractor’s petroleum operations expenditures are allowed deductions, which when they exceed the cost oil for a given year, the contractor carries them forward into subsequent years. The respondent submitted that the specification that deductions may be taken “only against cost oil” precludes them from being included in an assets’ cost base pursuant to S. 52(6) of the ITA.

 

The respondent agreed with the applicants that when the contractor disposes of an interest in a petroleum agreement previously acquired, S 89G of the ITA applies. The respondent submitted that regardless of whether the cost base is calculated under S. 89G(c) or S. 89G (d) the applicants are not entitled to include their exploration, development or production costs in their cost base in calculating the gain they realised on the disposal of their interest because the costs are only recoverable against cost oil. In contrast, under S. 89G (d) of the ITA, the applicants are not entitled to include incidental expenditures in their cost base.

 

The respondent contended that the applicants received US$ 150,000,000 as excess costs, from Heritage when they purchased the latter’s interest. The respondent argued that although CNOOC and Total may recover excess costs from cost oil, the applicants’ argument that their cost base should include the US$ 150,000,000 ignores the application of S. 89G (d) of the ITA. The respondent argued that under S. 89G (d) (i) the applicant’s cost base for purposes of calculating gain on the sale of Heritage’s interest cannot include the US$ 150,000,000. In calculating the applicants’ gain from the sale, the respondent reduced the applicants’ cost base by US$ 150,000,00 which were exploration costs that were deemed as excess costs under S. 89C(2) of the ITA and must be subtracted pursuant to S. 89G(d)(i) of the ITA. The respondent asked the Tribunal to allow the reduction of US$ 150,000,000 as excess costs that would be deductible by CNOOC and Total.

 

The respondent contended that the exploration costs of US$ 320,545,819 claimed to have been incurred by the applicants on EA1, EA2 and EA3A were not substantiated nor audited by the respondent. The applicants claim to have transferred these costs to Total and CNOOC, at the same time they seek to recover them by including them in their cost base. The respondent submitted that the US$ 320,545,819 were part of the bundle of rights and interests in the PSAs that was sold for the consideration of US$ 2,933,330,400. The respondent contended that they should not include them in the cost base because they are recoverable against cost oil. The respondent contended that Sections 89C (1) and 89C (2) do not disallow deductions for petroleum operation expenditures in the years where there is no sufficient cost oil; they merely suspend the deductions until future years.

 

The respondent contended that the applicants’ argument that prior to the commencement of commercial production, no deductions are allowed as there is no excess costs is a misreading of Part IXA of the ITA. The respondent argued that exploration, operation and development operations are by their very nature undertaken prior to the commencement of commercial production. S. 89C(1) of the ITA specifically permits deductions for exploration and development operations costs and limits these deductions to cost oil in the year they were incurred. The respondent concluded that the portion of excess costs that has been passed along to subsequent purchasers under S. 89G (a) of the ITA cannot be included in the applicants’ cost base for purposes of calculating their gain.

 

The respondent argued that an alleged loss claimed by the applicants is fictitious. The respondent claims that the applicants transformed what was a profitable transaction into a loss for tax purposes by applying the ‘last in, first out’ accounting method. The respondent submitted that what the applicants sold were undivided interests. The respondent, inter alia, cited Black’s Law Dictionary which defines “undivided interest” as “an interest held in the same title by two or more persons, whether their rights are equal or unequal as to value or quantity”. The respondent submitted that given the nature of such an interest, a taxpayer cannot choose the cost base that it wishes to allocate to a subsequent sale. The respondent cited the case of John K. McNulty v Commissioner of Internal Revenue, Tax Court (United States), T.C. Memo, 1988-274 where the court held that “A taxpayer who owns two undivided one- half interests in property received at different times, and disposes of an undivided one-half interest, is deemed to have disposed of 50 percent of each of the halves he owned.”  The respondent also cited the ruling of the Internal Revenue Service of the United States, 1967, the US case of Porter v United States, Court of Appeals for the Sixth Circuit (United States), 738 F.2d 731 and the UK case of Tod (Inspector of Taxes) v Mudd [1987] S.T.C. 141. The respondent averred that “it is not possible to treat portions of an undivided interest as separate and distinct interests.”

 

The respondent submitted that the LIFO accounting method is not only inappropriate but is also not acceptable under International Financial Reporting Standards. S. 40(1) of the ITA requires that a taxpayer’s methods of accounting shall conform to generally accepted standards. International Accounting Standard 2 specifies that “the Standard does not permit the use of the 'last in first out’ (LIFO) formula to measure the cost of inventories.”  The respondent also cited the case of Minister of National Revenue v Anaconda American Brass Ltd. [1956] A.C. 85 where the application of the LIFO was vitiated in the case.

 

The respondent contended that the applicants’ argument that “what the parties have agreed to sell must also determine what has been bought and sold for tax purposes” does not hold. Under S. 91 of the ITA, the Commissioner has powers to re-characterise a transaction that was entered into as part of a tax avoidance scheme, or does not have substantial economic effect or does not reflect the substance. The applicants contended that the cost base should be recalculated using either the FIFO method or the averaging method.

 

As regards incidental expenses, the respondent admitted that it accepted the applicants’ incidental expenditures of US$ 61,903,387 incurred with respect to Heritage interests. However, the respondent asked the Tribunal to exclude those costs. The respondent contended that S. 89G (d) governs the calculation of the cost base for a subsequent disposal of an interest in a petroleum agreement. Nothing in the Section allows a transferor to increase its cost base in the subsequent disposal by the amount of incidental expenditures.

 

On issue 3, the respondent submitted that the applicants are not entitled to reinvestment relief. The respondent argued that under S. 54(1) (c) a taxpayer must meet four conditions; (i) the disposal of the asset must be involuntary, (ii) the proceeds from the reinvestment must be reinvested, (iii) the reinvestment must be in an asset of a like kind, and (iv) the reinvestment in an asset of a like kind must be made within one year of the disposal. The respondent contended that the applicants have not met any of the four conditions.

 

The respondent alleged that the applicants have failed to discharge the burden of proving that the disposal of 16.67% interest was involuntary. Most of the evidence was based on the testimony of Mr. Paul McDade, which was based on his belief. In cross-examination of Mr. McDade, he admitted that there were no correspondences from the GOU. According to Mr. Martin Graham, GOU communicated through meetings, but these were un-minuted. Furthermore, Mr. Martin wrote a letter to the Minister of Energy and Mineral Development where he indicated that Tullow would farmdown at least 50% of their interest. The applicants requested the GOU to approve the creation of a basin-wide partnership where the applicants, CNOOC and Total were holding 33.33% interests each. According to Mr. Rubondo, it was Tullow that decided the award of 33.33% interests to each party. The respondent argued that the case of Uganda Revenue Authority v Bank of Baroda [2007] UGCommC 8 where the court held that the disposal by the bank of its shares was involuntary can be distinguished from the present case. In the said case there was an agreement unlike the current one before the Tribunal.  

 

The respondent submitted that the applicants are not entitled to the reinvestment relief because they did not reinvest the proceeds in an asset of a like kind. The respondent contended that the applicants’ claim that they used the proceeds from the sale of the interests in the PSA to fund pre-existing costs is incorrect. The respondent argued that S. 54(3) of the ITA required that the reinvestment be made in a “replacement asset”. The commonly accepted definition of replacement is “something that replaces”. The respondent claimed that from the evidence adduced the applicants did not use the proceeds from the sale of their interests to acquire new interests. According to the evidence of Mr. Graham, the proceeds from the sale were used to build infrastructure and others. The respondent argued that such expenditure was used to fund obligations under the PSAs that existed prior to the sale. It argued that such use of sale proceeds to fund pre-existing obligations is clearly not an acquisition of a replacement asset as required by S. 54(3) of the ITA. The respondent cited the US General Counsel Memorandum No. 39572 where it is stated that the reinvestment provision was intended to be a relief provision for a taxpayer to restore its economic position to the prior position. The respondent contended that the applicants by using the sales proceeds to fund their development obligations under the PSAs they are discharging pre-existing debt. This is not an asset of like kind acquired and there is no reinvestment at all. The respondent also argued that the applicant reinvestment was not made within one year of disposal.

 

The respondent submitted that in the event the Tribunal were to find that the applicants were eligible for reinvestment relief, the relief should be limited to a fraction of the amount to which they claim they are entitled. The involuntary disposal of interests represent 25% of the total interests that the applicants sold (16.67%/66.67% = 25%) which is US$ 41.3 million of the US$ 165 million the applicants claimed have expended on the PSAs.

 

The respondent prayed that the Tribunal dismisses the application and orders that the applicants pay the outstanding tax liability plus interest. They also prayed that the Tribunal finds that Article 23.5 of the EA2 PSA does not purport to provide an exemption to the imposition of tax pursuant to the ITA. If the Tribunal were to find that Article 23.5 of the EA2 PSA purported to provide an income tax exemption it would be null and void ab initio under the laws of Uganda. The Tribunal should find that the respondent is not estopped from imposing tax from the disposal of the interests in the EA2. The respondent also prayed that the Tribunal finds that the concept of legitimate expectation provides no basis for not imposing tax as imposed by the ITA. The respondent also wanted the Tribunal to find that the applicants disposed 66.67% of its 100% interest and not the 50% acquired from Heritage. It was also prayed that the Tribunal applies the average cost accounting method or in the alternative the FIFO’ method as the basis of calculating the gain obtained by the applicants. The respondent also wanted the Tribunal not to include the exploration, development or production costs including the excess costs acquired from Heritage in their cost base. The respondent also wanted the Tribunal to find that the applicants are not eligible for reinvestment relief. In the event the Tribunal finds otherwise, it should exercise its power under S. 19 of the TAT Act and remit the matter to the respondent for reconsideration. The respondent also prayed for costs of the application.

 

In its reply to the respondent’s submissions, the applicants complained about the approaches used by the former. They argued the respondent has raised new issues and arguments that were not raised before. They complained about the language use by the respondent.. The applicants argued that the respondent’s use of authorities from other jurisdictions does not take into consideration the weight such decisions may have and their relevance to the Tribunal. The applicants argued that some of the said authorities should be considered as evidence and not law. The respondent should not have relied on evidence improperly submitted to the court to which the applicants were not given an opportunity to challenge.

 

In respect of issue 1, the applicants replied that the respondent’s application of the principles of statutory interpretation in the analysis of Article 23.5 was flawed and simplistic. They argued that Article 23.5 of the PSA is a contractual provision and not a provision of a statute. What should be applied are the rules of interpretation of contracts and not statutory interpretation. The applicants argued that Article 23.5 of the PSA is not limited to transfer tax. The applicants argued further that it has never been any part of their case that income tax under Part IXA is a ‘transfer tax’. They do not dispute that income tax on gains imposed by the ITA is not a transfer tax. The applicants argued that Article 23.5 does not restrict itself to a transfer tax. To them, the issue before the Tribunal is whether or not the income tax charge or gains under the ITA is “any tax, fee or other impost or fee”. The applicants also argued that the language used in the ITA when considered in conjunction with the language used in Article 23.5, it is clear that an exemption was granted under the Article.  

 

The applicants submitted that the evidence of Mr. Rubondo and Mr. Kajubi in interpreting Article 23.5 of the EA2 PSA is inadmissible. Neither of them was a signatory to the PSA, or involved in negotiating the terms of Article 23.5 of the PSA. What the Tribunal should take into consideration is what a reasonable man would have considered as the intent in light of all background knowledge. Mr. Kajubi’s experience as Commissioner means that he is not likely to see the provision in the same way as the objective reasonable man. The applicants argued that the evidence of Mr. Richard Inch should be relied on. He testified that the intention of GOU was to bring on board partners who would share the risk of oil exploration.

 

The applicants also submitted that the respondent’s attempt to point to the provisions in the SPAs to support its interpretations was wanting. The SPAs were between different parties and were negotiated at different times approximately ten years apart. At the time the EA2 PSA was signed it was considered unlikely that any commercial oil or gas would be found. The SPAs are not between the GOU and the applicants. There are between the applicants and other commercial parties.

 

The applicants argued that the Minister of Finance could enter into agreement containing Article 23.5on behalf of the GOU. There is a difference when an exemption is granted by the Government as opposed to statutory body acting outside its powers. The applicants submitted that as a matter of constitutional law, the GOU was empowered to enter into Article 23.5 and the Minister acting for and on behalf of the GOU, had authority to sign the PSA.

 

The applicants argued that Article 152(2) of the Constitution does not say that tax can only be waived or varied. Article 152(2) merely provides that where a taxing law passed in accordance with Article 152(1) grants a person authority to waive or vary tax there must be periodic reports to Parliament by the said person. The ITA which is the taxing authority, the applicants submitted, confer general power[s] on any person or authority to waive or vary a tax imposed by that law. The applicants also argued that Article 23.5 of the EA2 PSA is not a “waiver or variation”. It is an exemption from tax, which tax is therefore never chargeable. It is not a waiver or variation granted “pursuant to a law enacted under Article 152(1). The applicants also argued that Article 23.5 of the EA2 PSA does not violate Article 152 of the Constitution for the simple reason that it does not involve “imposing” a tax.

 

The applicants also argued that the respondent’s application of Article 79 of the Constitution is misconceived. Article 79 applies to the power to make laws, not to the terms of an agreement. The applicants also argued that the respondent’s submission on Article 99 of the Constitution is not correct. Article 99 does not mention a restriction on the President’s authority to “waive the law”. The applicant argued that the President has power to grant a tax exemption. Granting an exemption does not show the Government’s failure to act according to the Constitution. The applicants argued that Article 99 of the Constitution should be read in conjunction with Article 113 of the Constitution. It provides for the delegation of powers to cabinet ministers. The Minister was appointed by the President with inherent powers to enter into agreements such as the EA2 PSA.

 

The applicants argued that the respondent’s reference to the removal of broad discretionary exemptions under the Income Tax Decree and the Investment Code has no relevance to the matter before the Tribunal. Firstly, they relate to completely different specific statutory powers granted to a different minister, the finance minister. Secondly, the said Decree and Code ceased to have effect in 1997 and the EA2 PSA was entered into by the Minister in 2001. The respondent’s assertion that S. 12 of the Income Tax Decree granted broad discretionary exemptions is inaccurate. S.12 provided specific statutory exemptions. The applicants argued that respondent does not rely on evidence in making these sweeping allegations of facts.

 

The applicants argued that the granting of a capital gains tax exemption in relation to assignment or transfer of an interest in EA2 PSA is clearly connected with the granting of a petroleum licence, and exploration or development under the licence as from the evidence of the witness. There is no reason why such an exemption should not be regarded as incidental to the matters set above.

 

As regards estoppel, the applicants argued that the respondent failed to distinguish between an act of government and an act of a statutory body. Article 23.5 is not ultra vires because the government did have power to enter in the EA2 PSA Article 23.5. The GOU is not a statutory body. Consequently it does not have statutory powers. The applicants posed a question: “If the government is not able to grant tax exemptions, then who can?” There is no statutory prohibition on the GOU giving a tax exemption. The GOU as a principal has powers to bind URA, its agent, and has done so. The applicants argued that the cases cited by the respondent in respect to estoppel are therefore not applicable. The respondent cannot identify a statutory power Article 23.5 is said to be in excess of.

 

The applicants contended that the respondent’s argument on the sale of undivided interests was an attempt to introduce a new issue that was not raised at the scheduling. The applicants did not adduce any evidence in respect thereof because they were not notified. They therefore argued that it would be manifestly unfair for the respondent to be allowed to argue this new point. The applicants also argued that for there to be undivided interests, there have to be two or more joint owners. From the moment the TUL acquired Heritage interests it alone held the whole of the interests in those PSAs. From that moment there was no “tenants in common, there was no “co-ownership”, which concepts are in land law. The applicants argued that the Tribunal is not concerned with the disposal of land.

 

The applicants submitted that the respondent was aware that they intended to sell Heritage interests since the drafts of the CNOOC/Total contracts were sent to the GOU and the respondent in October 2010. The applicants submitted that GOU approved the draft PSAs where Heritage interests were sold. The word “interest” was defined in the draft agreements to include the 16.67% interest of the original interests. The respondent issued its assessments knowing that the applicants were transferring Heritage interests.

 

 The applicants contended that the respondent did not give any authority as why it is opposed to the “last in first out” accounting method. They also argued that there is no support in Uganda or elsewhere for applying any other rule in respect of the disposal of an undivided interest.

 

As regards S. 89G of the ITA, the applicants argued that the cost base in respect of the Heritage interests comprises the Heritage gain less, if relevant, any “excess costs”. They are not seeking to “include the US$ 150,000,000 rather it is the respondent who should argue that such sum should be deducted from the Heritage gain as excess costs”. The applicants argued that there are no excess costs to date. The applicants argued that the respondent appears to be confusing the right to deduct expenditure under S. 89C with the deduction of excess costs from a transferee contractor’s cost base where it has disposed of its interest. The applicants submitted that S. 89C of the ITA limits the use of expenditure against profits from oil production but it does not cancel the relief in respect of a capital expenditure, in a computation of a capital gain under S. 52(6). To them, what S.89G(d) states is that what must be deducted from the transferor’s gain is the excess costs up to the date of the disposal deductible by the transferee contractor. At the date of disposal, there being no cost oil, there are no “excess costs” that can be deducted from the Heritage gain.

 

The applicants submitted that they are entitled to a deduction for their expenditure of US$ 320 million which was passed on to CNOOC and Total. As regards the respondent’s allegation that the applicants failed to substantiate the costs of US$ 320,545, 819 incurred as exploration costs, the applicants submitted that the said figure derives from communication between the parties in November 2012 and the tax returns for the year ended 31^st December 2009, submitted in June 2012 and provided in the communication in November 2012.

 

The applicants referred to their computation where the applicants purchased their interests from Heritage at US$ 775 million for EA1 and US$ 575 million for EA3A from which they deducted the purchase price for the Heritage interests, US$ 773,134,258 for EA1 and US$ 573,635,740 for EA3A, producing a loss. The applicants contended that the respondent misread S. 22 of the ITA. It only relates to insurance situations.

 

As regards the sale of Heritage interests, the applicants submitted that Heritage wanted to sell its interests to ENI. The applicants exercised their pre-emption rights to prevent this. The applicants wanted to acquire Heritage interests and as soon as consent was given to sell them off. Tullow, CNOOC and Total executed documents showing what that transaction was and the respondent issued assessment on capital gain on that basis. Hence there is no tax avoidance scheme. The applicants cited the case of Stanton v Grayton [1983] 1 AC 501 where the court focused more on what the agreement said. The question is: “how would a businessman see the transaction? Having regard to a businessman’s view, what one would conclude is that what were sold were Heritage’s interests.

 

In respect of reinvestment relief, the applicants argued that they are in principle, entitled to reinvestment relief under S. 54(1)(c) of the ITA. The applicants reiterated their position that the affidavits of Mr. McDade, Mr. Graham and Mr. Martin all showed that the applicants did not dispose off the 16.67% voluntarily. The applicants also presented slides to the GOU which indicated their desire to sell 50% interest.

 

The applicants argued that involuntary should be widely construed. It does not “require force but rather an action taken by a person who has no choice”. The evidence shows that the applicants acted involuntarily. They only wished to dispose of 50% of their interests but the GOU pressed them to dispose of another 16.67%. They argued that they did not provide evidence of “force”, whether improper or proper, because force was not necessary. The applicants cited again the case of URA v Bank of Baroda HCT -00-CC-CA-05-2005 where it was held that “one has to look at the agreement itself to ascertain its true intention...” As regards the respondent’s argument that the Bank of Baroda case involved an agreement unlike the one before the Tribunal, the applicants submitted that S. 54(1)(c) does not provide any proscription as to the circumstances in which the involuntary act must take place. Secondly the disposal of the 16.67% was contained in an agreement, namely, the MOU and the SPAs.  It was an express condition of the MOU that GOU’s consent was required to the farmdown.

 

The applicants also submitted that they could not present evidence at the hearing as to the expenditures incurred on the reinvestment relief as their one year period had not expired. This was because the respondent assessed the disposals before they had taken place. The dispositions were completed on the 21^st February 2012 and the one year period ran until 21^st February 2013. The hearing was on 26^th to 28^th November 2012 and 19^th to 21^st February 2012. This was a result of the respondent assessing the gain over a year before the disposals actually took place. The Tribunal was only asked to rule if the applicants were entitled to relief in principle.

 

The applicants argued that the respondent’s submission that the proceeds of sale can only be used to acquire an interest in a new PSA is not correct. The applicants cited Black’s Legal Dictionary which defines it, inter alia, as: “The act or process of replacing or being replaced; substitution.” The applicants have substituted the interests disposed of under the PSAs with interests in assets or rights which are dealt with under the PSAs. The reference in S. 54(1) (c) to “assets of a like kind” can simply be a reference to a contract, under which expenditure is made. The provisions do not require reinvestment in assets to be of an “identical” kind. Therefore, expenditures on “interest data” and “interest property” are expenditure on assets “of a like kind” within S. 54(1) (c). Expenditures were incurred on machinery, wells, facilities, offshore and onshore installations and structures.

6.    FINDINGS AND DECISION OF THE TRIBUNAL

 

      The Tribunal having read the witnesses’ statements, heard the evidence adduced, read the parties’ submissions and perused the authorities cited, wishes to rule as hereunder.

 

6.1   ARTICLE 23.5 OF THE EA2 PRODUCTION SHARING AGREEMENT (PSA)

 

On the 8^th October 2001, the applicants and the GOU executed a PSA under which the former were granted exploration, development and production rights in EA2. There were two Articles in the PSA that referred to taxation. The first one was Article 11 of the PSA, which read as follows:

“All central, local, district, administrative, municipal or other taxes, duties, levies or other lawful impositions applicable to the Licensee shall be paid by the Licensee in accordance with the laws of Uganda in a timely fashion.”

The said Article does not seem to be in dispute. The applicants were aware that they were required to pay taxes. The second Article which is the bone of contention is Article 23.5 of the EA2 PSA which purportedly attempts to exempt transactions which involve the assignment or transfer of an interest under the PSA from tax.  It does not seem to be in dispute, that the effect of Article 23.5 was to carve out from the main Article of tax liability, (i.e. Article 11), an exemption or a waiver of tax to the licensee or its assignee in respect of an assignment or transfer of an interest. What is in dispute is the interpretation of Article 23.5 of the EA2 PSA in light of the ITA. The applicants argued that Article 23.5 of the EA2 PSA offered an exemption to capital gains tax which is disputed by the respondent.

 

The applicants sold a portion of their interests in, inter alia, EA2 to CNOOC and Total. The respondent assessed the applicants, capital gains tax on the gain they purportedly received. The applicants objected to the assessment of capital gains tax in Block EA2 and claimed an exemption. The applicants called two witnesses who testified that because of Article 23.5 of the EA2 PSA they were not liable to pay capital gains tax in respect of the transfer of interests in EA2. According to Mr. Graham, the applicants relied on Article 23.5 of the EA2 PSA in their decision to farmdown. The applicants had incurred enormous expenditures and expected to recoup them when they sold a portion of their interests. Though Mr. Graham was not part of the legal team that drafted the PSA, he was its head. According to him, Article 23.5 exempted capital gains tax. The second witness, Mr. Richard Inch, the Head of Tax, stated that the applicants assumed that in the event of a farmdown the proceeds would be received tax-free because of Article 23.5. He was of the view that the exemption under Article 23.5 was valid.

 

The respondent’s witnesses gave evidence to the contrary. According to Mr. Rubondo, Article 23.5 was not negotiated by the parties. He testified that the GOU did not want licensees to be encumbered with fees, imposts and taxes. The intention of Article 23.5 was to facilitate the licensees to bring on board partners to share risk without the need to pay fees and imposts like stamp duties and signature bonuses. He said the clause was not meant to cover taxes on gains. Its purpose was to facilitate the sharing of risk and not to guide the taxation of a gain. According to Mr. Kajubi, the Commissioner Domestic Taxes, Article 23.5 was not part of the ITA. Capital gains tax is not a transfer tax. Hence it was not catered for under Article 23.5.

 

The Tribunal notes that while Mr. Rubondo and Mr. Kajubi were competent witnesses, the Tribunal does not think that they are the most appropriate persons to testify on the intention of the GOU in respect of Article 23.5. Firstly, there is no evidence that both were part of the negotiating or drafting team of the EA2 PSA. Secondly, the most appropriate person to testify on the intention of the GOU should have been the Attorney General or an official from his/her chambers. Under Article 119(3) of the Constitution, the Attorney General is the principal legal advisor of GOU. Article 119(4) (b) of the Constitution reads that the functions of the Attorney General include:

“to draw and peruse agreements, contracts, treaties, conventions and documents by whatever name called, to which the Government is a party or in respect of which the Government has an interest.”

The Tribunal cannot say that Mr. Rubondo and Mr. Kajubi are officials of the Attorney General’s chambers. Mr. Kajubi’s interpretation might have carried some weight; however the Tribunal has to caution itself against such testimony, as it is likely to be skewed in favour of revenue collection which is entrusted to his employer, Uganda Revenue Authority.

 

Intention can still be ascertained from the use of the words in an agreement. In Nile Bank (U) Limited v Translink (U) Limited [2001 – 2005] 2 HCB 53 it was noted that court must discern intention from words in a document.

Both parties gave lengthy submissions on the interpretation of Article 23.5 of the EA2 PSA. The applicants submitted that the disposal of their interests under Article 23.5 of the EA2 PSA falls under the ITA and is governed by S. 89G(c) which reads:

“Where a contractor, in this Part referred to as the “Transferor contractor” disposes of an interest in a petroleum agreement to another contractor or a person that as a result of the disposal will become a contractor in relation to those operations, in this Part referred to as the “Transferee contractor”-

The applicants submitted that there was a sale of interests as witnessed by the SPAs which transactions were completed on the 21^st February 2012. The ITA is applicable to said transactions.

 

The respondent submitted heavily on rules of statutory interpretation to determine whether the parties intended to grant an exemption. It submitted that capital gains tax was not a transfer tax. Hence it was not exempted by Article 23.5 of the EA2 PSA. However, the applicants objected to the respondent’s use of the rules of statutory interpretation as the EA2 PSA was an agreement and not a statute. The Tribunal agrees with the applicants on this point. The EA2 PSA is not a statute, it is an agreement. The rules of statutory interpretation may not be appropriate when interpreting agreements. The rules of statutory interpretation may be important when determining whether an agreement is in compliance with a statute but not the intentions of the parties or to assign meanings to words or in determining how a reasonable man would interpret  a document.

 

The applicants argued that in order to get a good interpretation of the Article, the intention of the parties is important. Did the parties intend Article 23.5 to include an exemption to capital gains tax? While the applicants’ witnesses testified that Article 23.5 intended to cover an exemption, we cannot say what the position of the GOU is. There was no witness from the Attorney General’s chambers. The Tribunal notes that the GOU which was a party to the PSA is not a party to the application before it. Under Article 119(4) (c) of the 1995 Constitution, the functions of the Attorney General include to represent the GOU in courts or any other legal proceedings to which the GOU is a party. However the TAT Act envisages one respondent, Uganda Revenue Authority. Though the Uganda Revenue Authority is an agent for GOU, it did not sign the EA2 PSA. The contractual obligations of the GOU cannot be determined when it is not a party before the Tribunal. However, the Tribunal is not interested in the contractual obligations of the parties. What is of interest to the Tribunal are the tax liabilities of the taxpayers, in this case the applicants. Tax liability is set by statute. Be what it may, what the parties say was their intention may not help when it comes to determining tax liability. Where an agreement is involved, the taxman should determine whether it is in line with the taxing legislation. Does Article 23.5 of the EA2 PSA afford protection to the taxpayers, the applicants? This involves interpretation of the Article 23.5 of the EA2 PSA in light of the ITA.

 

The taxman has to make an objective analysis or interpretation of the agreement in light of the statutory provisions. In Investors Compensation Scheme Ltd V West Bronwich Building Society 1998 1 ALL ER 98 Lord Hoffman LJ said:

“(1) Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation which they were at the time of the contract.

 (2) The background was famously referred to by Lord Wilberforce as the matrix of fact; but this phrase is, if anything, an understated description of what the background may include. Subject to the requirement that it should have been reasonable to the parties and to the exception to be mentioned next, it includes anything which would have affected the way in which the language of the document would have been understood by a reasonable man.

(3) The law excludes from the admissible background the previous negotiations of the parties and their declarations of subjective intent. They are admissible only in an action of rectification. The law makes this distinction for reasons of practical policy and in this respect only, legal interpretation differs from the way we would interpret utterances in ordinary life.

(4) The meaning which a document (or any other utterance) would convey to a reasonable man is not the same thing as the meaning of its words. The meaning of words is a matter of dictionaries and grammar; the meaning of the document is what the parties using those words against the relevant background would reasonably have been understood to mean...”

The said authority was cited in Golden Leaves Hotels and Resorts Limited and Apollo Hotel Corporation V Uganda Revenue Authority Civil Appeal 64 of 2008. The Tribunal is interested in how a reasonable man would have interpreted Article 23.5 of the EA2 PSA in light of the ITA rather than the intentions of the parties. As stated above, the previous negotiations of parties and their subjective intent are admissible only in an action of rectification. The Tribunal is not interested in rectifying the EA2 PSA. What is of concern to the Tribunal would be the meaning a reasonable man would convey to the document in respect to an exemption to capital gains tax and not the meanings of words. The meaning of words may not be the same as the meaning of a document as the latter involves the parties using the words against the relevant background.

                                                   

Where the agreement involves government, for once, the taxman may have to forget that he is collecting taxes for the government. What should be considered is the use of the words in the agreement and the relevant background. The background that may be relevant, in this case, is that the EA2 PSA was entered into by GOU for the exploration, production and development of oil. By the time the EA2 PSA was signed no oil had been discovered. Article 23.5 was incorporated in the agreement to entice oil companies in the oil exploration venture. However what may not be clear is whether Article 23.5 was to encourage oil companies invest in the venture or was it to facilitate them transfer off their interests to other investors? This can only be resolved by looking at the wording of the Article in relation to the relevant statute.

 

In order to understand whether Article 23.5 included capital gains tax one would need to look at the statutory provisions which define the tax payable. It is a bit surprising that when the parties were trying to interpret Article 23.5 of the EA2 PSA, none referred to the description of capital gains tax under the ITA and compared it with the Article. The relevant Sections in the ITA include S.18 which defines what business income is, and reads:

“(1) Business income means any income derived by a person in carrying on a business and includes the following amounts, whether of a revenue or capital nature-

1. the amount of any gain, as determined under Part VI of this Act which deals with gains and losses on disposal of assets...”

S. 50 of the ITA which deals with disposals of assets reads:

          “(1) A taxpayer is treated as having disposed of an asset when the asset has been

                (a) sold, exchanged, redeemed, or distributed by the taxpayer;

                  (b) transferred by the taxpayer by way of gift; or

                (c) destroyed or lost.”

S. 18 states that a disposal of an asset is business income. S. 50 shows that a disposal of an asset includes when an asset has been sold or exchanged.

 

The applicants cited Article 23.5 of the EA2 PSA, as their shield against income tax liability arising from a capital gain. Article 23.5 read as follows:

“The assignment or transfer of an interest under this Agreement and any related Exploration or Production Licence shall not be subject to any tax, fee, or other impost or fee levied either on the assignor or the assignee in respect thereof.”

For an interest to be exempt from any tax there should be an assignment or a transfer. Is an ‘assignment’ or’ transfer’ under Article 23.5 of the EA2 PSA the same as a ‘sale’ or ‘exchange’ under S. 50 of the ITA? The Black’s Law Dictionary 8^th edition p, 128 defines assignment as follows”

“1.The transfer of rights or property <assignment of stock options>. ... 2. The rights or property so transferred < the aunt assigned those funds to her niece, who promptly invested the assignment in mutual funds>.”

A transfer is defined under Black’s Law Dictionary (supra) p. 1536 as:

“1. to convey or remove from one place or one person to another; to pass or hand over from one to another, esp. to change over the possession or control of. 2. To sell or give.”

S. 50(1) (a) of the ITA provides for “sold, exchanged, redeemed, or distributed by the taxpayer.” A sale is defined by Black’s Law Dictionary (supra) p. 1364 as:

“1. The transfer of property or title for a price... 2. The agreement by which such a transfer takes place.