DEMOCRATIC REPUBLIC OF TIMOR-LESTE
NATIONAL PARLIAMENT
Taxation of Bayu-Undan Contractors Act
Explanatory Memorandum
Portuguese original law
English translation of law
Introduction
This memorandum provides an explanation of the Taxation of Bayu-Undan Contractors Act (referred to as the “the Act”), which provides for the taxation of contractors undertaking petroleum projects in Bayu-Undan. The basic effect of the Act is to preserve the existing income tax treatment of such contractors subject to the modifications provided for in the Act, including the imposition of additional profits tax.
1. Short Title
This article provides that the Act may be cited as the Taxation of Bayu-Undan Contractors Act, 2003.
2. Definitions
This article provides for the interpretation of words and terms used in the Act.
Sub-article 1 provides definitions of commonly used terms in the Act. The definitions of “petroleum” and “petroleum activities” are the same as in the Timor Sea Treaty. “Petroleum project” is defined to mean petroleum activities taking place in Bayu-Undan. It is expressly provided that petroleum activities taking place in Elang Kakutua Kakutua North do not constitute a petroleum project for the purposes of the Act. This is particularly relevant for article 5 of the Act.
A “contractor” is defined to mean a Tax Subject that has entered into Production Sharing Contract JPDA 03-12 or 03-13, or a successor contract. The definition also includes any successor or assignee of such a Tax Subject. For a Tax Subject to be a contractor, it must be registered as a contractor under the Petroleum Mining Code.
Sub-article 2 provides that terms not defined in sub-article 1 have their ordinary meaning under the Law on Income Tax, Law on Value Added Tax on Goods and Services and Sales Tax on Luxury Goods, Law on General Tax Provisions and Procedures, UNTAET Regulation No. 2000/18 (as amended) and the Timor Sea Treaty, as the case may be. As regards the Law on Income Tax, Law on Value Added Tax on Goods and Services and Sales Tax on Luxury Goods, and the Law on General Tax Provisions and Procedures, terms have the meaning in those laws to the extent that those laws are applicable in East Timor as determined under UNTAET Regulation No. 1999/1.
Sub-article 3 provides a priority rule in the event of a conflict between the Act and Law on Income Tax, Law on Value Added Tax on Goods and Services and Sales Tax on Luxury Goods, Law on General Tax Provisions and Procedures (as these laws apply in Timor-Leste) or UNTAET Regulation No. 2000/18 (as amended). In the event of such conflict, the Act prevails.
3. Taxation of a Contractor Undertaking a Petroleum Project
This article states the general principle of taxation of contractors undertaking the petroleum project.
Sub-article 1 provides that a contractor is subject to tax in accordance with the Law on Income Tax, Law on Value Added Tax on Goods and Services and Sales Tax on Luxury Goods, and Law on General Tax Provisions and Procedures. This is subject to several qualifications. First, sub-article 2 makes it clear that it is only to the extent that those Laws apply in East Timor. This is determined in accordance with UNTAET Regulation 1999/1. Secondly, the application of the Laws is subject to the modifications in UNTAET Regulation 2000/18 (as amended). See, in particular, Chapters VII (wages income tax), X (taxation procedure) and XI (additional tax, offences and penalties). Thirdly, the application of those Laws is also subject to the modifications in Part 2 of the Act explained in these notes.
Sub-article 3 provides that the rate of corporate tax applicable to a contractor is 30%.
Sub-article 4 exempts Tax Subjects from tax with respect to income and activities relating to the construction, installation and operation of an export pipeline (as defined in article 2).
4. Decommissioning Costs Reserve
This article allows a contractor to claim a deduction for the amount carried to the decommissioning costs reserve for a fiscal year in respect of a petroleum project.
Sub-article 1 states the principle of deductibility. It is expressly provided that sub-article 1 overrides Article 9(1)(c) of the Law on Income Tax, which provides that no deduction shall be allowed for the establishment or accumulation of a reserve fund. The amount allowed as a deduction for a fiscal year is the amount carried to the decommissioning costs reserve for the year. Decommissioning costs actually incurred during a fiscal year are either deductible under Article 6 of the Law on Income Tax or amortized under Article 11A of the Law on Income Tax, depending on the useful life of the costs incurred.
Sub-articles 3 and 4 provide for two important limitations on the deduction. First, sub-article 3 provides that the establishment and carrying of amounts to the decommissioning costs reserve must be based on the total decommissioning costs approved by the Designated Authority in accordance with the contractor’s Decommissioning Plan. This includes any revision of the total decommissioning costs estimated to be incurred, provided the Designated Authority approves the revised amount. The amount carried to the reserve is determined under the relevant Production Sharing Contract.
Secondly, sub-article 4 provides that no deduction is to be allowed for amounts carried to the decommissioning costs reserve for any fiscal year prior to 1 January 2008.
The deduction allowed under sub-article 1 is for amounts carried to the decommissioning costs reserve. Sub-article 2 ensures that there is no double deduction when decommissioning costs are actually incurred. In broad terms, there is no deduction for actual costs incurred unless they exceed the amount carried to the reserve.
Sub-article 5 applies if, at any time, the total amount allowed as a deduction under this article exceeds the total approved decommissioning costs. In this case, the amount of the excess is included in the contractor’s gross income for the fiscal year in which the excess occurs.
5. Depreciation and Amortization
This article provides for the depreciation of tangible property, and the amortization of intangible property and other expenditure in respect of the petroleum project.
Sub-article 1 applies to the depreciation of tangible property. The effect of the sub-article is that the depreciation rules in Article 11 of the Law on Income Tax apply to tangible property acquired by a contractor for use in exploration in respect of a petroleum project subject to the modifications in paragraphs (a)-(d).
Under Article 11 of the Law on Income Tax, a taxpayer may use either the diminishing value or straight-line methods of depreciation for tangible property. The depreciation is to be based on the useful life of the asset and is calculated on the basis of pooling of assets. Paragraphs (a) – (d) set out four modifications in the calculation of the amount of depreciation in relation to tangible property -
(1) Paragraph (a) limits contractors to straight-line depreciation calculated on a single asset basis.
(2) Paragraph (b) sets out the depreciation rate schedule.
(3) Paragraph (c) provides that the depreciation of any property acquired before first commercial production commences from the date of first commercial production. This is determined under sub-article 6(a).
(4) Paragraph (d) provides for the calculation of the amount of depreciation. As stated above, this is straight-line depreciation on a single asset basis.
Sub-article 2 makes equivalent modifications to Article 11A of the Law on Income Tax in its application to intangible property used, and other expenditures incurred by a contractor in relation to the petroleum project.
Sub-article 3 provides for the treatment of a terminal loss incurred by a contractor in respect of petroleum activities in Elang Kakutua Kakutua North. If the contractor has undertaken a petroleum project, the undeducted amount of the loss is treated as an amount of notional expenditure incurred by the contractor in respect of the project. The expenditure is treated as having been incurred at the later of the date the Elang Kakutua Kakutua North activities ceased or the date of first commercial production for the Bayu-Undan project. This means that the loss cannot be amortized before the date of first commercial production for the Bayu-Undan project. The expenditure is treated as having a useful life of five years and is amortized under Article 11A of the Law on income Tax in calculating the contractor’s taxable income for the Bayu-Undan project.
Sub-article 4 provides for apportionment of the amount allowed as a deduction under sub-article 1(d) or 2(d) in the fiscal year of first production. Sub-article 5 provides for an adjustment in the last fiscal year of depreciation or amortization (as defined in sub-article 6(b)) to ensure that relevant asset or expenditure is fully depreciated or amortized.
6. Special Calculation Norm
This article specifies a Special Calculation Norm for the purposes of calculating the taxable income of a permanent establishment of a contractor in certain circumstances.
Article 15 of the Law on Income Tax provides that Special Calculation Norms may be specified for the purposes of calculating the net income of certain taxpayers. The Special Calculation Norms apply in priority to the normal rules for the calculation of taxable income under Article 16 of the Law on Income Tax.
Sub-article 1 provides that the net income of a permanent establishment of a contractor engaged in oil and gas drilling activities for the petroleum project is 6% of the gross income. Sub-article 2 provides that the net income of a permanent establishment of a contractor engaged in shipping and air service activities for the petroleum project is 2.4% of the gross income. “Gross income” and “permanent establishment” have their meanings in the Law of Income Tax. It is expressly provided that the Special Calculation Norm applies for the purposes of calculating the tax instalment payments of the permanent establishment under Article 25 of the Law on Income Tax.
7. Estimated Net Income
This Article provides for the calculation of the estimated net income applicable to compensation paid by a contractor for certain services relating to petroleum projects for the purposes of Article 23(1)(c)(2) of the Law on Income Tax.
Paragraph (a) applies to compensation paid by a contractor or subcontractor for oil and gas drilling support services, acquired for the petroleum project. It reduces the estimated net income from 30% to 12% of the gross compensation. Tax under Article 23 of the Law on Income Tax is withheld at the rate of 15%. This means that the amount to be withheld from such compensation is 1.8% of the gross compensation.
Paragraph (b) applies to compensation paid by a contractor or subcontractor for technical, management, accounting and book-keeping, legal consulting and tax consulting services acquired for the petroleum project. It reduces the estimated net income from 40% to 16% of the gross compensation. Tax under Article 23 of the Law on Income Tax is withheld at the rate of 15%. This means that the amount to be withheld from such compensation is 2.4% of the gross compensation.
Paragraph (c) applies to compensation paid by a contractor or subcontractor for rent or other income relating to the use of property for the petroleum project. The estimated net income is reduced to 16%. Tax under Article 23 of the Law on Income Tax is withheld at the rate of 15%. This means that the amount to be withheld from such compensation is 2.4% of the gross compensation.
8. Withholding Tax
This article modifies the withholding tax rates applicable to certain items of income.
Sub-article 1 reduces the withholding tax rate applicable under Article 23(1)(c)(3) of the Law on Income Tax on royalties paid by a contractor or subcontractor from 15% to 6% of the gross amount of the royalty paid.
Sub-article 2 provides that the withholding tax rates determined under Article 4(2) of the Law on Income Tax applicable to compensation for construction services acquired for the project is 0.8% and consulting services is 1.6%.
Sub-article 3 applies to compensation paid by a contractor or subcontractor for services acquired in respect of the petroleum project. It reduces the withholding tax rate under Article 26(1)(c) and (d) of the Law on Income Tax for such services from 20% to 8% of the gross amount of compensation. This is subject to sub-article 4, which provides that the withholding tax rate under Article 26(1)(d) applicable to compensation paid to employees is 20%.
9. Branch Profits Tax
This article provides that the branch profits tax in Article 26(4) of the Law on Income Tax does not apply to a contractor or subcontractor in respect of income derived from a petroleum project.
10. Value of Gas
This article provides for the valuation of natural gas (as defined in sub-article 2) for the purposes of calculating the taxable income of a contractor in respect of the petroleum project. Paragraph (a) of sub-article 1 provides that the valuation of natural gas produced and saved, and not used in field operations, is to be made in accordance with the Production Sharing Contract governing the project. Paragraph (b) makes it clear that no deduction is allowed for any export cost charge except to the extent that the charge has not been taken into account in determining the valuation of natural gas produced and saved pursuant to paragraph (a).
11. Imposition of Additional Profits Tax
This article provides for the imposition of additional profits tax (“APT”) on a contractor undertaking the petroleum project.
Sub-article 1 imposes APT on a contractor who has a positive amount of accumulated net receipts for the project for a fiscal year. The accumulated net receipts of a contractor for a fiscal year is calculated according to the formula in article 12. By virtue of article 20, APT is imposed for the fiscal year commencing 1 January, 2002 and subsequent fiscal years.
Sub-article 2 provides for the calculation of the APT payable by a contractor a fiscal year. In broad terms, the APT payable is the accumulated net receipts of the contractor for the year multiplied by 22.5%, with the resulting amount grossed-up by the income tax rate specified in Article 3(3) (i.e., 30%).
Sub-article 3 makes it clear that any APT payable by a contractor for a fiscal year is in addition to the contractor’s ordinary income tax liability for the year.
Sub-article 4 provides that any APT paid by a contractor is a deduction in the calculation of the taxable income of the contractor for the fiscal year in which the APT is paid.
12. Accumulated Net Receipts
This Article provides for the calculation of the accumulated net receipts of a contractor for the petroleum project.
Sub-article 1 provides that the contractor’s accumulated net receipts for a fiscal year is calculated according to the specified formula. Component A is the contractor’s accumulated net receipts at the end of the previous fiscal year. Sub-article 2 provides that the amount of component A for a fiscal year is zero if the contractor paid APT for the previous fiscal year. This means that component A will always be either zero or a negative amount. Sub-article 4 provides a transitional measure for a contractor under Production Sharing Contracts JPDA 03-12 and 03-13. Component A of the formula for the fiscal year commencing on 1 January, 2002 (i.e., the first fiscal year of the APT) is to be calculated on the basis that the accumulated net receipts of the contractor as at 25 October, 1999 was negative $233 million. The contractor is to notionally apply the formula in sub-article 1 for the period 25 October, 1999 – 31 December, 2001. The resulting amount is treated as component A of the formula for the fiscal year commencing 1 January, 2002,
Component B is the contractor’s net receipts for the current fiscal year. This is calculated in accordance with Article 13.
Component I is the total of any interest or other financial charges paid by the contractor for the current fiscal year. It is entered as a negative amount. Sub-article 3 provides that where component (A x 116.5%) is negative for a fiscal year, the subtraction of component I(1-r) for that year is not to reduce the amount of ((A x 116.5%) – I(1-r)) to an amount that is less than component A. For example, if A is -$200m for a fiscal year, then the amount entered in the formula for the year as I(1-r) is not to exceed $33m. The amount of any excess is not carried forward or carried back to any fiscal year.
Component r is the corporate tax rate specified in Article 3(3).
13. Net Receipts
This article provides for the calculation of the net receipts of a contractor for a petroleum project for a fiscal year. The net receipts are the gross receipts of the contractor for the year less the total deductible expenditure of the contractor for the year. The gross receipts of the contractor are calculated in accordance with Article 14 and the total deductible expenditure is calculated in accordance with Article 15. It is expressly provided that the net receipts of a contractor for a fiscal year may be negative.
The net receipts of a contractor for a fiscal year is component B of the formula in article 12 for that year.
14. Gross Receipts
This article provides for the calculation of the gross receipts of a contractor for a fiscal year for the petroleum project. It is relevant to the calculation of the contractor’s net receipts for the project for the year under Article 13.
Sub-article 1 provides that the gross receipts of a contractor for a fiscal year for the project is the sum of the following amounts –
(1) Paragraph (a) includes the gross income of the contractor received in the fiscal year for the project. The reference to “gross income” is a reference to the concept of gross income that forms the basis for the computation of taxable income under Article 6 of the Law on Income Tax. This is basically the sum of the amounts specified in Article 4 of the Law on Income Tax. It is expressly provided that the contractor’s gross income includes any amounts received from the hiring or leasing out of, or the granting of rights to use property. It is also expressly provided that gross income for the purposes of calculating gross receipts does not include the contractor’s interest income.
(2) Paragraph (b) includes the consideration received by the contractor in the year for the disposal, destruction or loss of any property used in the project where the expenditure incurred in acquiring the property was deducted under article 15 in calculating the net receipts of the contractor for any fiscal year. “Property” is to be interpreted broadly. It expressly includes any materials, equipment, plant facilities and intellectual property or rights.
(3) Paragraph (c) includes the consideration received by the contractor in the year from the provision of information or data obtained from any survey, appraisal or study relating to the project where the expenditure incurred in undertaking the survey, appraisal or study was deducted under article 16 in calculating the net receipts of the contractor for any fiscal year.
(4) Paragraph (d) includes the total of any other amounts received by the contractor in the year that is a reimbursement, refund or other recoupment of an amount previously deducted in computing the net receipts of the contractor for any fiscal year.
(5) Paragraph (e) includes the consideration received in respect of property includes any compensation, indemnity or damages received by the contractor for the loss or destruction of the property.
Sub-article 2 provides that the gross receipts of a contractor does not include any amount received as consideration for the transfer of an interest in the petroleum project. This is subject to Article 16.
Sub-article 3 provides for apportionment of any amount derived or received that is only partly attributable to a petroleum project.
15. Deductible Expenditure
This Article provides for the calculation of the total deductible expenditure of a contractor for a fiscal year for the petroleum project. It is relevant to the calculation of the contractor’s net receipts for the project for the year under Article 14.
Sub-article 1 provides that the total deductible expenditure of a contractor for a fiscal year for the project is the sum of the following amounts –
(1) Paragraph (a) includes the total of amounts incurred in the year by the contractor in respect of the project and allowed as a deduction under Article 6 of the Law on Income Tax in calculating the taxable income of the contractor. It is expressly provided that this includes interest expense and financing charges. Paragraph (a) does not include depreciation and amortization deductions as the full amount of the expenditure is deductible under paragraph (b).
(2) Paragraph (b) includes the total capital expenditure incurred by the contractor in the year in acquiring assets (tangible and intangible) for use in the project.
(3) Paragraph (c) includes the total exploration expenditure incurred by the contractor in the year in respect of the project.
(4) Paragraph (d) includes the East Timor income tax of the contractor for the year calculated by applying the corporate specified in Article 3(3) (i.e., 30%) to the taxable income of the contractor for the year computed before allowance of the deduction of APT.
Sub-article 2 provides that the deductible expenditure of a contractor does not include any amount incurred as consideration for the transfer of an interest in the petroleum project. This is subject to Article 16.
Sub-article 3 provides for apportionment of any amount paid that is only partly attributable to a petroleum project.
16. Transfer of Interest in a Petroleum Project
This Article applies where a contractor disposes of its interest in a petroleum project. In this case, the transferee contractor takes over the transferor’s gross receipts and deductible expenditure for the fiscal year in which the transfer takes place calculated as at the date of the transfer. The transferee contractor also takes over the transferor’s component A of the formula in article 13 for the fiscal year in which the transfer takes place.
17. Procedure Relating to Additional Profits Tax
This article provides for procedural matters relating to the imposition of APT.
Sub-articles 1 and 2 oblige a contractor to lodge an APT return for a fiscal year. The return must be lodged by the same date as the contractor’s annual income tax return for the year. According to Article 3 of the Law on General Tax Provisions and Procedures, this is three months after the end of the fiscal year.
Sub-article 3 provides that a contractor’s APT for a fiscal year is due and payable on the same date as the contractor’s income tax is due and payable for that year. APT is collected in instalments as determined under Article 18.
Sub-article 4 provides that the procedural rules in the Law on General tax Provisions and Procedures (as amended by UNTAET Regulation No. 2000/18) apply for the purposes of the assessment and collection of APT and any additional tax imposed in relation to an APT liability, and for appeals against a contractor’s assessed liability for APT or additional tax.
Sub-article 5 provides that Chapter XI of UNTAET Regulation No. 2000/18 applies for the purposes of APT. The combined operation of sub-article 5 and Chapter XI of UNTAET Regulation No. 2000/18 results in the imposition of additional tax in the following cases –
(1) A failure to lodge an APT return by the due date.
(2) A failure to pay APT or an instalment of APT by the due date.
(3) An understatement of the amount of APT declared in an APT return.
(4) A failure to create and retain records for the purposes of APT.
The combined operation of sub-article 5 and Chapter XI of UNTAET Regulation No. 2000/18 also results in the following offences –
(1) A failure to create and retain records for the purposes of APT.
(2) Obstructing or hindering the Commissioner in enforcing APT.
(3) A failure to provide information or the provision of false information concerning APT.
(4) Evasion of APT.
18. Instalments of Tax
This article provides for the payment of APT by instalments.
Sub-article 1 provides for monthly instalments of APT. Each instalment is due on the 15th day after the end of the month. The first instalment for the fiscal year is for the month of January and is due on 15 February. If that date is not a business day, then the APT is due on the next business day. This treatment mirrors that applicable to the payment of the ordinary income tax.
Sub-article 2 obliges a contractor to deliver to the Commissioner an estimate of contractor’s additional profits tax liability for a fiscal year by the payment date of the first instalment for that year (i.e., 15 February). The amount of each instalment is one-twelfth of the estimate.
Sub-article 3 provides that the estimate remains in force for the whole of the fiscal year unless the contractor delivers a revised estimate to the Commissioner. A revised estimate applies to instalments due both before and after the revised estimate was delivered to the Commissioner. The sub-article also provides for the treatment of underpaid and overpaid tax as a result of a revised estimate.
Sub-article 4 provides that the Commissioner is to estimate the APT payable by a contractor for a fiscal year where the contractor fails to deliver an estimate as required under sub-article 2. The Commissioner’s estimate remains in force for the whole of the year unless the contractor revises the Commissioner’s estimate in accordance with sub-article 3.
Sub-article 5 provides for the imposition of additional tax where the contractor’s APT estimate for a year is less than 90% of the actual APT payable by the contractor for the year.
19. Regulations
This article provides that the Minister responsible for finance has the power to make regulations for the effective carrying out of the provisions of the act.
20. Entry into Force and Application
This article provides that the Act enters into force upon satisfaction of the conditions specified in sub-article 1. APT applies for the fiscal year commencing on 1 January, 2002 and subsequent fiscal years.
