Indonesia changes law to avoid Cost Recovery abuse

Jan 14, 2018 News

…Govt.’s audit in two years uncovers US$221.5 million in ineligible expenses

By: Kiana Wilburg

Natural Resources Minister, Raphael Trotman

When countries such as Guyana, are on the brink of becoming an oil producer, a host of problems emerge. One of them involves verifying the claims for expenses made by oil operators. Determining whether these claims are accurate is no easy task.

It is an area that has posed many difficulties for countries; even those with some of the most foolproof systems in place. The Indonesian government for example has long believed that oil companies were inflating cost recovery expense claims in order to maximize revenue.

The Government was particularly concerned in the years prior to 2010, when oil production was declining yet cost recovery claims were increasing significantly.

As a result of repeated and significant disputes following the auditing of expenses, Indonesia decided to put an end to the abuse by implementing new laws. The government put in place the “Government Regulation concerning Cost Recovery and Provisions on Income Tax in Oil and Gas Activities” (Government Regulation No. 79/2010).

The regulation specifically states how costs are to be treated and what can be deemed recoverable. There are also several auditing tests which it must go through. According to the regulation, the cost recovery claims by Government must be related to oil and gas operations within the contract area; they must be based on the arm’s length principle between affiliated companies, and they must be approved in advance by government authorities in the work program and budget.

More interestingly, the regulation explicitly excludes 22 categories of expenses that are neither cost recoverable nor tax deductible.

Examples of expenses that are now explicitly labeled ineligible include Expenses for personal interests of executives, expatriate employees and families; Incentives, pension and insurance for executives, expatriate employees and families; Expenses incurred before the signing of the contract; Excessive material surpluses due to mistakes in planning and/or purchases; Tax and legal consultant fees unless directly related to oil operations; Contractors oil and gas marketing fees; Expenses for the technical training of expatriates; Expenses for mergers, acquisitions, or transfers in participating interests; Procurement of goods and services exceeding approved value by 10%.

While it was successful in removing some uncertainty around the eligibility of cost recovery claims, major disputes still continue in Indonesia.

Be that as it may, the Indonesian Government was still able to prove that it was justified in its move to change its laws regarding cost recovery. In this regard, a government audit of cost recovery claims between 2010 and 2012 found US$221.5 million in ineligible expenses. (SEE LINK FOR MORE DETAILS https://cipmoz.org/images/Documentos/Industria_Extrativa/309_Spinformacao_2014_05_en.pdf)

COST RECOVERY

Oil production is expected to get into full swing by March 2020. That is two years away. But even at this point, the Government is yet to point out what ‘specific’ measures are in place to ensure that it can authenticate cost recovery claims by USA oil giant, ExxonMobil.

At a recent press conference, Natural Resources Minister, Raphael Trotman said that the authenticity of cost recovery claims was one of the main discussions he and others had with the International Monetary Fund (IMF) and its experts.

Trotman acknowledged that indeed, several countries around the world, Kenya, Ghana, the USA and Great Britain, have had struggles with ensuring cost recovery is precise and transparent .

The Natural Resources Minister said, “We have turned to some of the best financial experts in the world and they have come, they have done their assessments and they will be guiding us. It is a work in progress and we are doing better by the day.”

When Kaieteur News still insisted on him outlining a few provisions in this regard, he pointed out that the Guyana Revenue Authority was able to garner $900M in taxes due to its attentiveness in this regard.

DISADVANTAGE

Guyana’s limited resources will certainly put it at a disadvantage when it comes to verifying the accuracy and reasonableness of cost recovery claims which will be made by ExxonMobil.

This is according to Chartered Accountant and former Auditor General, Anand Goolsarran.

The anticorruption advocate insists that the coalition Government should consider renegotiating the contract it has with ExxonMobil to allow for a revenue-sharing model to be in place, similar to that which currently exists in Indonesia.

PROFIT VS. REVENUE SHARING

In a profit-sharing arrangement, Goolsarran explained that the oil company uses the revenue derived from production to recover its capital and operational expenditure. This he said is known as ‘cost oil’.

The remainder, known as ‘profit oil’, is split between the government and the company. Goolsarran said that the extent to which countries have a dual arrangement in place (i.e. royalty plus profit-sharing), it stands to reason that royalty rates will be lower than those that receive royalties only. In Guyana’s case, it is only receiving a two percent royalty.

According to Goolsarran, a key concern relating to profit-sharing arrangements is that profits can vary significantly from year to year. He said that this can be as a result of the unpredictability of prices on the world market and the need to recover the initial investment over a period of time.

Goolsarran said that countries such as India, Tanzania and Indonesia are experiencing significant difficulties in terms of their ability to independently verify the reasonableness of the expenditure that is charged against revenue to arrive at a profit.

The Chartered Accountant said that given the uncertainty of the extent of profits that is likely to accrue; there are strong arguments for there to be in place, revenue sharing agreements rather than those relating to profit-sharing.

The former Auditor General said that a revenue-sharing agreement provides a guaranteed flow of income to governments once production begins, and can be monitored easily from the government’s perspective.

He said that there will no longer be a need for detailed and independent scrutiny of oil companies’ costs to ensure that only legitimate expenditure is charged against revenue. He said that this is an area that has been the subject to intense disagreements between oil companies and governments.

An additional consideration Goolsarran highlighted, is that oil companies can curtail production in anticipation of higher prices in the future, with consequent adverse impact on profits. He said that it was mainly for these reasons that India has moved away from the profit-sharing model to one of revenue-sharing, based on a recommendation of the country’s Auditor General.