Kenya Revenue Authority (KRA) has been allowed to collect over 2.2Billion from Africa Oil Kenya BV in unpaid Value Added Tax (VAT). The High Court in a judgement delivered on 30th November 2022 dismissed an appeal by Africa Oil Kenya BV that had challenged the decision of the Tax Appeals Tribunal confirming the demand for unpaid Corporation Tax and VAT.
The Tribunal had observed that the company, being in the oil and gas business with interests in various oil and gas exploration blocks in Turkana had entered into farm-out agreements for the various oil blocks where it assigned its rights to other companies and received income from them. The company however stated that the said farm-out transactions were a ‘sale of its business’ and not a taxable supply subject to VAT under section 2 of the VAT Act, 2013.
A farm-out agreement is most commonly used in the oil, natural gas, and mineral industries. It is an agreement signed by an owner of property known as ‘farmor’, when leasing their resource-producing property to another person called a ‘farmee’, for the purposes of development. In exchange for leasing out their property, the farmor receives royalties on any income that is generated by the outsourced production or development. The agreement is beneficial to a landowner when the owner wants to maintain its interest in the property and any natural resources the property may produce but cannot afford to undertake the operations on their own.
It was the position of KRA that these farm-out agreements constituted taxable supplies and thus ought to have been charged VAT. The Tribunal, in agreement with the KRA’s position stated that a farm-out is a supply of a capital asset and that supply of capital asset is a taxable supply in accordance to section 5(1) of the VAT Act. Africa Oil Kenya BV was aggrieved by the decision taken by the Tribunal and appealed to the High Court.
The High Court affirmed the Tax Tribunal’s decision which was also KRA’s position that farm-out agreements are structured in a way that Africa Oil Kenya BV retains an overriding reversionary interest in the farmed-out area after “payout” and once the farm-out is complete, the interest reverts to Africa Oil Kenya BV who may consequently work out an agreement for revenue sharing with the other party in the agreement. The Court proceeded to state categorically that “a farm-out agreement can only be treated as a new economic venture between the farmor and farmee rather than a sale of property or services”.
The High Court has allowed KRA to collect Kshs. 2,293,334,065.44 from Africa Oil Kenya BV being unpaid VAT for the years 2011, 2012 and 2015.
Commissioner, Legal Services & Board Coordination – Paul Matuku