Value Added Tax in the GCCInsights by industry | Volume 2

Ninety years in the Middle East

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Deloitte | Value Added Tax in the GCC | Oil and gas industry

Extracting VAT fromthe oil and gassupply chain – whowill bear the burden?

Chapter 3 – Oil and gas industry

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Deloitte | Value Added Tax in the GCC | Oil and gas industry

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The oil and gas sector remains animportant and significant part of each ofthe Gulf states. Businesses in the sectorinclude large national oil companies andtheir associated entities, international oilcompanies with local operations (ortrading in the area) – both in ‘upstream’exploration and production activities and‘downstream’ marketing activities, andservice companies providing specialistresources and expertise to the sector. The introduction of VAT will have differingimpacts for each type of industryparticipant.

Many in the sector anticipate that theremay be a VAT relief applying to the oil andgas sector in some form – but even if thisis the case, VAT is still anticipated to havean impact on all businesses. We explainbelow some common avenues for VATrelief applied on oil and gas activitiesinternationally, and how these affectbusinesses across the supply chain. Weexplore the effect of VAT on cash flow –which looks to be an important issueacross the sector – and look at somecomplexities of international operations.Finally, we explore two practical issues forcompanies in the upstream sector.

Potential avenues for VAT relief in thesectorWhilst the fall of oil prices has had asignificant effect on the sector, oil and gasremains an important industry in each ofthe GCC states. Many expect thatgovernments will not apply VAT across theentire sector, but will instead providesome form of relief (such as an exemptionor zero-rate, for example) to lessen theburden of companies working in thesector.

Even if a VAT relief of some form doesapply, this is unlikely to mean that VAT willhave no effect on industry participants.Industry participants should be careful tounderstand any special rules that may

apply; there are varying potential forms ofrelief which may have significantly differentfinancial and operational implications.Based on international models, some ofthe potential treatments and theirimplications are explored below.

a. The standard position – VAT ischarged on all transactions (takingplace within the territory)Many jurisdictions do not apply anyspecial VAT treatment to upstream ordownstream activities: VAT is in theorycharged at the standard rate on sales ofproducts and on services provided to oilcompanies. Despite this, in practice theinternational nature of the industry – bothfor extraction activities and sales ofcrude/product - often result in VAT notbeing applied under standard VAT rules.For example, a zero rate generally appliesfor products exported outside of acountry, and exploration activities outsideof a country’s VAT territory.

Applying VAT in this way is conceptuallystraightforward – but businesses mustdeal with international complexities oftheir operations (discussed further below),and additional cash flow requirementswhere VAT does arise in the supply chain.Most European jurisdictions follow thismodel.

b. A zero-rate applies to sales ofcertain extracted products, or morewidely across the sectorSome countries apply a specific zeropercent rate to sales of certain products inthe sector (such as South Africa). For thesupplier of zero-rated goods, thispreserves their eligibility to claim an inputtax credit for VAT incurred on theirpurchases, whilst no VAT needs becharged on sales. For this reason a zerorate is often viewed as a favorable positionfor these suppliers. Businesses makingpredominantly zero-rated supplies musthowever anticipate cash flow effects of

Many in the sectoranticipate that there maybe a VAT relief applying tothe oil and gas sector insome form – but even ifthis is the case, VAT is stillanticipated to have animpact on all businesses

Deloitte | Value Added Tax in the GCC | Oil and gas industry

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paying VAT to suppliers – values of whichcan often be significant for capital andoperational expenditure used in thesector - and seeking VAT refunds fromauthorities.

The scope of any zero rate must becarefully considered. It is uncommon for a specific VAT relief to apply to domesticconsumption of oil and gas. A distinctionmay therefore exist to restrict the zerorate to certain products or certainupstream activities. Businesses mustcarefully examine to what extent they are covered by any such relief.

c. A sector-wide exemption applies to specified oil and gas companiesA different type of VAT relief involvesproviding full exemption from VAT forcompanies operating in the oil and gassector. Unlike the standard VATexemption, which results in a restriction to VAT recovery, a full sector exemption asapplied in some countries – particularly inAfrica – allows oil and gas companies tonot have VAT charged on their purchases.Often, this requires oil and gas companiesto provide certificates to eligible suppliersto allow purchases without VAT. Thecertification process introduces additionaladministrative process and tax authorityscrutiny to the supply chain. Impropercertification can result in VAT beingsuffered in the supply chain, despite asector exemption applying in theory.

Cash flow effects will be a keyconsideration in the sectorWhether one of the forms of sector relief described above applies or not, the cash flow implications of VAT need to be considered and planned upfront by all businesses working in the sector.Businesses making predominantly zero-rated or non-VAT liable supplies (e.g.under a VAT relief sector, or making salesfor export) can expect to be in a regularVAT refund position, as credits for VAT onpurchases will exceed VAT collected on

sales. Even at a 5% rate, the impact of VATwill be significant for large commoditytransactions and on capital expenditure.The timeframes for monetizing VATreceivable balances will depend onindividual tax authority practices; will ataxpayer need to file a refund claim withsupporting documentation, or will therebe a standard timeframe allowed forauthorities to verify or audit a VATrepayable position?

International supply chains bringcomplexityOil and gas companies have traditionallyfaced challenges in understanding andmanaging VAT obligations acrossinternational supply chains. The sale andpurchase of crude and refined productsgives a technical VAT obligation in thecountry where each transaction takesplace. This can often result in unexpectedVAT registration requirements orobligations to charge VAT where productsare purchased and sold in overseasjurisdictions. Businesses must ensure theyunderstand the VAT landscape and theirobligations in any country where they haveoperations, and also in any countrieswhere they transact.

The cash flow implications of VAT needto be considered and planned upfrontby all businesses working in the sector.Businesses making predominantly zero-rated supplies or supplies notsubject to VAT can expect to be in aregular VAT refund position, as creditsfor VAT on purchases will exceed VATcollected on sales.

Deloitte | Value Added Tax in the GCC | Oil and gas industry

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Whilst the concept of a zero rate forexported products in internationalpractice generally reduces VAT costs for international movements of productsor equipment, exporters must take care to collect and maintain commercialdocumentation to support zero-rating inthe case of tax authority scrutiny. Thisprocess should be sufficiently robust to beable to have timely access to documents,even where another party (such as afreight agent or a customer) is responsiblefor carrying out the export formalities.

Exploration phase – recovery andregistrationThe oil and gas lifecycle may involve a long period of exploration and upfrontinvestment until the asset (e.g. the oil orgas field) is in production phase - and firstoil or gas is extracted. Until this time, thebusiness is unlikely to make any suppliesfrom that asset which would give acorresponding right to VAT registration or recovery of VAT on costs.Internationally, many jurisdictions allowbusinesses to be VAT registered, and to recover VAT incurred during thesepreliminary phases – otherwise, VATincurred could form an additionalirrecoverable cost and discourageinvestment in future projects. Ultimately,

the VAT recovery position during thisphase is likely to be a matter dependenton the specific rules in each country. If anupfront registration is not possible in aparticular country (and this was certainlyan issue in Malaysia when they introducedVAT), then businesses should explore what steps may be possible to ensureexploration and development costs areincurred by a company (or group) that is able to recover the VAT. In any case,forecasts for projects may need to includecontingencies for irrecoverable VAT.

Cost sharing in joint venturearrangementsMany exploration projects are carried outas joint venture agreements, with multipleentities holding interests in the eventualproduction, and contributing their share inthe development and operating costs ofthe projects. The sharing of costs betweenentities in this way (whether within a groupor between third parties) is likely to beviewed as a set of separate transactionson which VAT should be charged, unlessan exemption applies. The VAT treatmentof cost-sharing arrangements can often be unclear where a charge is made for ashare in a bundle of costs; even when amajority of costs might not be liable forVAT in nature (e.g. work carried out on an

offshore rig outside the VAT territory), theVAT treatment for the bundle of servicesmay revert to the default ‘taxable’ position.Upstream companies involved in jointventure agreements should review theircontractual position and ensure that theagreements in place remain fit forpurpose upon the introduction of VAT.

ConclusionsThe oil and gas sector has a number ofcomplexities – and the introduction of VATacross the GCC will doubtless add extraconsiderations for businesses across thesupply chain. Whilst VAT is not intended to be an overall cost to businesses, it isalmost certain that industry participantswill feel a cash flow effect and will berequired to comply with additionaladministrative obligations. Practically, VATinefficiencies may result in a cost beingborne at some part in the supply chain.Upstream and downstream businessesshould examine their operations andexisting arrangements to determine howVAT may affect them, and to ensure theyare ready for the new world of VAT.

The VAT treatment of cost-sharingarrangements can often be unclearwhere a charge is made for a share in a bundle of costs

Deloitte | Value Added Tax in the GCC | Oil and gas industry

This publication has been written in general terms and therefore cannot be relied on to coverspecific situations; application of the principles set out will depend upon the particularcircumstances involved and we recommend that you obtain professional advice before actingor refraining from acting on any of the contents of this publication. Deloitte & Touche (M.E.)would be pleased to advise readers on how to apply the principles set out in this publication totheir specific circumstances. Deloitte & Touche (M.E.) accepts no duty of care or liability for anyloss occasioned to any person acting or refraining from action as a result of any material in thispublication.

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