Exemption from UAE’s Corporate Tax: Fiscal Terms in Upstream Oil and Gas Agreements

In recent years, the UAE’s upstream petroleum sector has seen an influx of private capital, underscoring its robust and dynamic market. This vibrant activity is primarily concentrated in Abu Dhabi, home to most of the UAE’s oil and gas reserves. Nonetheless, other Emirates have also proven successful in attracting international investments by initiating bid rounds and entering into partnerships with oil and gas companies through a range of granting instruments.

Granting instruments in the upstream oil and gas sector refers to the various types of agreements that host government enters with oil and gas companies (contractors), and which govern the exploration, development, and production of petroleum resources. These include concessions, production sharing agreements (PSAs), service agreements, and other similar arrangements, each with unique characteristics and terms.

In the UAE, concession agreements are mainly used in Abu Dhabi and Sharjah, while PSAs are more common in Ras Al Khaimah.  The fundamental objective of these agreements is the same: they grant oil and gas companies the right to explore and produce petroleum within a defined territory of the Emirate for a specified term. While the majority of the provisions are similar across these agreements, key differences lie in the fiscal terms, which govern the financial interactions between the parties involved.

Nonetheless, some commonalities can also be observed in fiscal terms. Both PSAs and concessions are fundamentally profit-sharing mechanisms although they use different approaches: PSAs are based on production sharing, while concessions rely on taxation and royalty; further the tax deductions (in concessions and in some PSAs) and cost recovery (in PSAs) serve the same function of determining the profit pool available for distribution or taxation, though the cost recovery limit is a unique feature of PSAs. Moreover, elements like host government participation are common to both types of agreements and although less frequent, some PSAs also include royalties. Understanding these distinctions and similarities are important for exploring the implications of these fiscal terms from UAE corporate tax perspective.

Oil and gas regulations

In the UAE, the upstream petroleum sector is not governed by a singular, overarching petroleum law. However, several federal laws play an important role, including the Constitution of the United Arab Emirates (1971), Federal Decree No. (55) of 1974 On Increasing the Royalty in all Concession Agreements of Petroleum Companies Working in the State, Federal Law No. (24) of 1999 Concerning the Protection and Development of the Environment and recently enacted Federal Decree-Law No. (47) of 2022 On Corporate and Business Tax (CIT Law) among others.

Under the Constitution, the natural resource of an Emirate is the public property of that Emirate. Therefore, each Emirate independently engages the private capital and enters into oil and gas agreements with contractors to explore and produce its petroleum resources.

Regulatory oversight is primarily carried out at the Emirate level, organized through: (a) a regulatory body in each Emirate overseeing oil and gas operations, ensuring environmental compliance, and awarding granting instruments, and (b) National Oil Companies (NOC) responsible for managing operations and entering into agreements with the contractors.

Tax

Taxation of upstream operations includes a tax imposed by the respective Emirate and a Federal corporate income tax.

In the late 1960s some of the Emirates enacted income tax decrees, which, although rarely enforced in practice, were relevant primarily for the oil and gas sector. Under the decrees, the income tax rate could reach up to 55%. Nonetheless, the fiscal terms, including taxation at Emirate-level, in upstream granting instruments in the UAE are predominantly defined and governed by individual agreements negotiated between the contractor and the grantor (Emirate). These provisions relate specifically to Emirate-level taxes and do not extend to the Federal corporate income tax.

At the federal level, CIT Law imposes a 9% tax. However, oil and gas companies engaged in both extractive (upstream) and non-extractive (midstream and downstream) activities can be exempted from corporate income tax provided they meet specific conditions.

Exemption from corporate tax

For extractive industries, the primarily conditions for exemption from federal corporate income tax under CIT Law include: (a) the contractor must hold an interest in an extractive business under a right, license, or concession issued by the relevant Emirate, (b) the contractor must actually be subject to tax under the applicable legislation of an Emirate, and (c) the Ministry of Finance must be notified, as stipulated in Article 7 of the CIT Law.

Of particular importance is condition (b), which stipulates that to be exempt from the 9% CIT, the oil and gas company must effectively be subject to taxation under the applicable legislation of the respective Emirate. Article 7 of CIT Law further clarifies that “effectively subject to tax” involves the Emirate imposing taxes on income or profits, royalties on revenues, or other forms of taxes, duties, and levies in respect of the contractor’s extractive business.

In general terms, a tax is a compulsory payment levied and enforced by a governmental authority, resulting in redistribution of wealth from businesses to the state. The tax is not, by its nature, the result of a mutual negotiation between the government and the private party but rather a sovereign act. The language of Article 7 of the CIT Law, using terms such as “imposing” and “subject to Emirate legislation,” could seem to suggest that fiscal measures enacted via commercial agreements, rather than through Emirate legislation, may not qualify for exemption from the 9% corporate income tax. If this were to be true, contractors would be liable for the 9% CIT, which could, in turn, influence the negotiation of fiscal terms for the contractor to meet its profitability target, affect its assessment of a commercial viability of the discovery, or impact the local government’s overall take.

Effectively subject to tax

In December 2023, the UAE Federal Tax Authority issued a Guide on Taxation of Extractive Business and Non-Extractive Natural Resource Business (Tax Guide), which clarified the requirements of Article 7 of the CIT Law.

The Tax Guide acknowledges the reality in UAE upstream petroleum sector that taxes are “typically set on a case-by-case basis under the relevant concession agreement or similar arrangement with the local government.” Specifically, the Tax Guide identified three broad instruments under which a contractor will be considered as subject to taxation in the relevant Emirate:

• Tax Decree: an income tax levied under the tax regulations of the respective Emirate.
• Agreement: a royalty on production or sales or another fiscal measure stipulated in the agreement with the local government.
• Other: any other form of tax, charge, or levy imposed by the local government.

This guidance contrasts with the general understanding of tax as a sovereign action imposed rather than negotiated contractually. That being said, it is a welcome clarification, mitigating the risk that the contractually set tax measures between the Emirate and the contractor may not be recognized as constituting effectively being subject to taxation under the Emirate’s legislation for purposes of CIT Law.

Even more important is the clarification in the Tax Guide that “effectively being subject to taxation” should be interpreted broadly encompassing any form of tax, charge, or levy as long as it is payable on income, profits, or revenues. However, it remains to be seen how broadly it is intended for this interpretation to be applied. A key consideration is whether the main fiscal terms commonly found in the petroleum granting instruments in the UAE would meet the Article 7 requirements for exemption. Particularly significant are fiscal measures such as production sharing, government participation, bonuses, royalties and rental payments, which are the primary means by which the Emirates derive income from petroleum operations.

Production sharing

In PSA regimes, the contractor initially recovers their costs (“cost oil/gas”), and the remaining “profit petroleum” is then shared between the government and the contractor. Production sharing is based on a predetermined ratio, which can be fixed or, more commonly, variable, such as the r-factor (revenue to cost ratio), rate of return (based on discounted cash flow), daily rate of production, or a combination thereof. This setup may represent the largest source of government revenue.

From the perspective of CIT Law, as clarified by the Tax Guide, such a contractual instrument between the Emirate and the contractor is sufficient to meet the definition of being “imposed by the local government.” However, does it also meet the requirement (as clarified in the Tax Guide) of being payable on the income, revenue, or profit? The issue becomes more complex when the government opts to take its share of petroleum in kind, rather than cash. Does a payment in kind qualify as a tax, charge, or levy? In some instances, however, the contractor may act as an agent for the grantor, selling the government’s take and then remitting the proceeds in cash.

Technically, in a production sharing context, the host government does not impose a charge on the income, profits or revenues generated by the contractor. Rather, the government receives a portion of the profit petroleum, which is the profit left after cost recovery in the relevant accounting period. From this standpoint, there is no direct imposition of a tax payable on income.

Yet, from another perspective, considering the Tax Guide’s emphasis on broadly interpreting fiscal measures, as well as its express acknowledgement that the contractual instruments such as concessions or PSAs represent the (local) governmental act, it may be conceivable to view the Emirate’s periodic take from the profit petroleum as essentially a form of tax. This view may be supported by the fact that, in a typical tax/royalty regime (such as concession), profits are taxed after cost deduction, whereas in PSAs, the government takes a part of the profit after the cost recovery. The key difference lies in the terminology – tax and profit share, cost deduction and cost recovery – and not as much in the underlying principle. In fact, as already mentioned, both concessions and PSAs can be viewed as profit-sharing mechanisms with different methods for extracting rent by the host government. From this perspective, any profit the local government takes in PSA regime may be considered as the contractor being “effectively subject to tax.” Nevertheless, it remains unclear whether it can be classified as a fiscal measure similar to a tax.

Government participation

Government participation allows the local government to acquire a share (participating interest) in a project, typically following a commercial discovery by the contractor. It is prevalent in both concession and PSA regimes, although contractual structures may vary. For example, during the 2019 bid round for Sharjah’s onshore concession areas, SNOC’s (Sharjah’s National Oil Company) participation interest in certain concession areas reached 50%. Similarly, in Abu Dhabi concessions, ADNOC (Abu Dhabi National Oil Company) generally retains the right to 60% interest in the production phase.

In PSA regimes, government participation rates are usually lower. If the host government has right to participate in the project through its NOC or another entity, it will typically compensate the contractor for the costs corresponding to its participating interest incurred by the contractor during the exploration/appraisal stages. In some PSAs, the compensation may also include an uplift (interest).

The question is whether government participation would be considered a type of fiscal measure to qualify for an exemption under CIT Law. In PSA context, when the host government has participating interest, NOC becomes part of the contractor group. After cost recovery and production sharing, profit petroleum received by the contractor group is then further divided between the contractor and the NOC based on their participating interests. From a taxation perspective, such a distribution of profit between the contractor and the NOC would not typically be viewed as a tax imposition. However, fundamentally, this arrangement could be seen as a “subsequent phase” of production sharing between the host government and the contractor, where the local government (through its NOC) and the contractor further share the profit. Thus, the considerations discussed in relation to production sharing could also be relevant for government participation. Nevertheless, classifying it as a fiscal measure similar to a tax remains uncertain.

Bonus

A bonus is a payment made by the contractor to the host government, which is typically event driven. For example, a signature bonus is paid at the contract signing stage, while production bonuses may occur upon reaching certain production milestones or bonus may be payable during the extension of the granting instrument’s term.

The signature bonus is not tied to the revenue, income, or profit generated by the contractor. In contrast, the production bonuses are typically calculated based on the amount of oil equivalent per barrel, reflecting the volume of production (but not necessarily the profitability). Thus, while production bonuses may be linked to the output levels and indirectly to income, it remains unclear from the perspective of CIT Law and the Tax Guide whether such a connection to production would be considered as “payable on income, profits, or revenues.”

Rent and royalty

A rental payment is a fixed amount paid by the contractor to the host government, either periodically throughout the duration of the agreement or calculated per square kilometer of the concession area. This payment is not payable on income but is instead associated with the land area covered by the agreement. Consequently, it is unlikely to meet the criteria for being classified as a “tax” under CIT Law.

Royalty in granting instruments typically represents a percentage of gross production value. While characteristic of concession agreements, occasionally they may appear in PSAs, but this is rare. Royalty clearly meets the criteria for the 9% CIT exemption and even the Tax Guide itself cites a hypothetical example where a royalty is deemed to satisfy the condition of being “effectively subject to tax.”

The Tax Guide provides important insights for the contractors to assess their liability for corporate income tax when entering into oil and gas agreements with the respective Emirate. It clarifies that some contractually negotiated fiscal measures are likely to qualify for exemption from the UAE’s corporate income tax, provided other conditions are met. This is crucial for both the contractors and Emirates as they navigate the financial aspects of their agreements.

In the UAE, concession agreements are typically based on royalty/tax fiscal terms. Consequently, the inclusion of taxes and royalties in the granting instrument will likely enable the contractors to qualify for the exemption from the 9% corporate income tax if other conditions of Article 7 of CIT Law are also met.

However, the situation is somewhat different with PSAs. In PSAs, while royalties and taxes may occur, this is usually not the case, with emphasis being on production sharing and potentially bonuses. Given this variation, it becomes important for the contractors engaged in PSAs to carefully assess whether the fiscal measures stipulated in these agreements meet the criteria for the 9% CIT exemption.

For further advice please contact our Senior Associate Baqar Palavandishvili at [email protected]

Baqar Palavandishvili Senior Associate [email protected]

The article is for informational purposes only and is not intended to serve as legal or tax advice. Readers should not rely on the information provided here for making tax-related or legal decisions. For specific advice, it is essential to consult with a specialist tax and legal advisor.