Icing on the cake

It came at the last minute. For two years, the Ministry of Finance and the Lebanese Petroleum Administration (LPA) have been drafting a tax law focused specifically on the oil and gas industry. In late September, Parliament approved it just in time for the law to potentially govern the first oil and gas exploration and production contracts the state hopes to sign during or before Spring 2018 (with bids due October 12).

Contract signature is not a given, but with the passage of the tax law, Lebanon’s oil and gas fiscal regime is finally complete. The new law is tailored for the oil and gas industry and imposes higher tax rates on oil and gas companies than it does on other corporations registered or operating in the country. Corporate income tax, for example, is set at 20 percent in the oil and gas tax law, as opposed to the 15 percent corporate income tax imposed by existing legislation (even higher than the approved but annulled hike to 17 percent).

The oil and gas tax law was initially slated for parliamentary debate in August, but lack of quorum scuttled the discussion. In early September, partially because the law had not yet been passed, the LPA recommended postponing the deadline for submitting bids in the country’s first offshore oil and gas licensing round from September 15 to October 12 (a new deadline officials insist will not change—see story page 16). Model contracts oil and gas companies will use to bid include a so-called stabilization clause, which protects companies from tax increases that come after contract signature. Stabilization clauses are common in the oil and gas industry as a way to hedge tax increase risk given that oil and gas exploration and production contracts typically run 30 years or more in duration. By passing the new oil and gas tax law before signing contracts, the state will increase its tax revenue under any contract, or contracts, signed as a result of the first licensing round.

Targeted tax language

As is common around the world, Lebanon’s new oil tax law is industry-specific, explains LPA board member Wissam Zahabi. Aside from a higher corporate income tax rate for the sector, there are other differences between this tax law and the standard Lebanese tax code. Some differences—such as an unlimited time period for carrying forward losses, as opposed to the three-year limit in the standard tax code—are incentives for the industry. Others, however, are designed to keep oil and gas companies honest when it comes to reporting costs and revenues (key factors that will impact the government’s overall take from potential future revenues from the sector). One example is enshrining the concept of “arm’s length” transactions in the oil tax law. This means transactions between related and affiliated companies are evaluated as if they occurred between unrelated entities in a freely competitive environment. Zahabi elaborates: “[Oil companies sometimes] don’t tell you their right price. Let’s say you buy it from an affiliated company for five, they’ll tell you for six. They’d like to inflate the cost. Or whenever they sell, they sell at a lower price, and they tell you higher. So it goes both ways for cost as well as for revenue. If it’s an expense, they have an incentive to say it’s higher, if they’re selling they’ll say they sold it at a low price to cash in more profit.” This is important because the government’s portion of revenues from the sector is directly related to the costs and revenues of their contractual partners, the oil companies.

Lebanon’s fiscal toolbox

Taxes are only one means of several the Lebanese government will use to capture revenue from the sector. Additionally, the model contracts impose a royalty on both oil and gas production. According to the contracts, the royalty on gas is set at 4 percent and the royalty on oil ranges between 5 and 12 percent based on the amount of production. Royalties can be taken in cash or in kind meaning oil companies either deliver the government oil and/or gas it can use, or sell on its own; they can give the state the requisite cut of commodities the companies sell on their own; or they can do a combination of both.

In addition to royalties and taxes, the government will have a share of hydrocarbon production as well. Like royalties, this share can be taken in cash or in kind, but unlike royalties, the share progressively increases over time. The government’s share is biddable in the model contracts and related to project cash flows. Deepwater drilling is expensive, and the time frame between incurring expenses (drilling) and realizing revenues (production) can stretch to several years. As is standard in the industry, Lebanon’s model contracts allow companies to recover their costs. Production-sharing “payments” from companies to the state (whether in cash or in kind) will be made quarterly. Each quarter, companies can deduct their costs from revenues and the contracts call for a recovery ceiling of 65 percent. This is a biddable item, so companies may well bid lower than 65 percent to produce a more attractive offer from the state’s perspective.

What this means is that until costs are recovered, every quarter that companies generate revenues from oil and/or gas sales they are able to “keep” at least 65 percent of those revenues, splitting the rest with the state. The initial split must be at least 30 percent, according to the contracts. This percentage, however, is also biddable, meaning it can be higher. The other two biddable fiscal components relate to the revenue split percentage after costs are recovered and the point at which this new percentage will be triggered (i.e., once costs have been recovered by a factor of 1.5).

A step in the right direction

Passing the oil tax law was important for the sector because it completed the fiscal regime. The government’s share of benefit from this sector comes from multiple sources—as is current international best practice—and having all of the rules in place from the start is wise from a regulatory perspective. There is still, however, a bit of work to be done in terms of passing a few implementation decrees so the law’s provisions are fully enforceable, Zahabi says. As for how the law stacks up against other global tax laws, Zahabi says the LPA hired consultants to help draft it, referred to OECD guidelines, and benchmarked Lebanon against eight other countries to produce the law. Passing it just weeks before bids are due, he speculates, will not have an adverse impact on how ready companies are to present their bids because they arguably saw this coming. “We’ve already done some presentations about it, so we gave them the general headlines,” he says.

Matt Nash

Matt is Executive's Economics & Policy Editor. He has been reporting on Lebanon since 2007 with a focus on oil and gas, policy and legal matters.

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