VENEZUELA: THE TAX MAN COMETH TO THE OIL COMPANIES

C O N F I D E N T I A L CARACAS 001496 SIPDIS NSC FOR TSHANNON AND CBARTON ENERGY FOR DPUMPHREY AND ALOCKWOOD TOKYO FOR SFLATT E.O. 12958: DECL: 05/10/2015 TAGS: EPET VE SUBJECT: VENEZUELA: THE TAX MAN COMETH TO THE OIL COMPANIES REF: CARACAS 1230 Classified By: A/DCM RICHARD SANDERS, FOR REASONS 1.4 (d) -------------- SUMMARY -------------- ¶1. (C) As of April 18, the GOV increased the tax rate levied on the 22 international oil companies operating in Venezuela under "Operating Service Agreements." The GOV then declared May 10 that the companies had cheated on their taxes to the tune of some $2 billion over the past ten years and that it will perform tax audits retroactive to 2001. The tax authorities met May 10 with a first group of the companies involved, urging them voluntarily to revise their tax returns and threatening them with possible fines. A local consulting firm notes that it is not yet clear whether the audit process will include a retroactive application of the new 50 percent tax rate. Energy Vice Minister Mommer informed a senior U.S. company manager the week of May 2 that the GOV is simply looking to adapt the U.S. and British oil and gas tax model and that it has not yet decided on its ultimate model. The executive said, however, that it is clear the model will include "ring fencing," i.e., the companies will no longer be able to declare the losses of one project against the gains of another. End Summary. -------------- TAX AUDITS -------------- ¶2. (U) A senior Venezuelan tax official stated May 10 that the international oil companies involved in the 32 Operating Service Agreements (OSAs) with PDVSA took advantage of a low tax rate and inflated costs to avoid payment of $2 billion in taxes over the past ten years. This followed President Chavez's comments in his weekly "Alo Presidente" program on May 8 in which he said that if companies do not pay past-due taxes, "they can leave." ¶3. (U) The GOV increased the tax rate levied on these projects from 34 to 50 percent as of April 18 and has now announced that it will perform tax audits retroactive to ¶2001. Venezuela has a two-tier regime for industrial taxes, a 34 percent standard industrial tax, and a 50 percent tax rate for oil exploitation. According to Article 11 of the tax code, "those...dedicated to the exploitation of hydrocarbons and connected activities such as refining and transport, or the purchase or acquisition of hydrocarbons and derivatives for export, are subject to the tax envisioned in Article 53 b)," i.e., 50 percent. (Note: This rate has been reduced during the Chavez administration from 67.7 percent.) Article 11 specifically exempts any projects handling Venezuela's extra heavy crude, including the production of orimulsion, as well as natural gas projects from the 50 percent tax. At the time the Operating Service Agreement contracts were negotiated, however, the operators were deemed to be simply providing a service for PDVSA and thus paid the 34 percent tax. A former senior PDVSA official has informed econoff that the bidding terms for the Third Round contracts specifically noted that the 34 percent income tax would apply. ¶4. (U) In a May 10 meeting organized by AVHI, the association representing international oil companies, officials of SENIAT, the IRS equivalent, met for the first time with six of the 22 companies that participate in the OSAs -- CNPC (China),ENI (Italy),Petrobras (Brazil),Teikoku (Japan), Total and Perenco(both French). According to press reports, the tax authorities invited the companies voluntarily to revise their tax returns. In additional to the back tax, reported the press, the fine levied on any company that made such a voluntary re-filing would be one percent of the taxes owed. The fine after the audit would increase to ten percent. The tax officials reportedly also told the companies that if any company sought to litigate SENIATE audit results before the Venezuelan courts, a decision in favor of SENIAT could result in possible penalties of 125 percent above the initial finding. (Note: Econoff raised the penalty issue in a meeting with an associate of Baker & MacKenzie. He reported that Venezuelan law calls for numerous fees above the amount initially taxed or penalized by Seniat. However, he said, Seniat's track record in winning cases in the courts is poor. End Note.) ¶5. (U) As with many of the recent allegations the GOV has flung at the international oil companies, the ground rules of the proposed audit are not yet clear. The VenEconomy consulting group raises the question of whether the audit process will include a retroactive application of the new 50 percent tax rate. -------------- TAX CHEATS? -------------- ¶6. (U) Econoff discussed the GOV's allegations of tax cheating with several company managers who agree that there are companies involved in the OSAs that are not paying cash taxes. For one thing, some companies have taken significant losses because some of the OSA fields proved to be poorer than expected (ChevronTexaco, which has written off hundreds of millions of dollars of losses on the LL-652 block, is a case in point). These losses, as well as credits and offsets allowed by Venezuelan tax law have, in some cases, taken the place of paying cash taxes. In these circumstances, while the GOV may wish to challenge the assumptions made by the companies, there is an obvious difference between designing corporate taxes to minimize the tax burden and the cheating alleged by the GOV. -------------- INDUSTRY TAX STRUCTURE IN FLUX -------------- ¶7. (C) ChevronTexaco President for Latin America Upstream Ali Moshiri contacted econoff May 5 followed a meeting he had had earlier in the week with Vice Minister Bernard Mommer. Mommer informed Moshiri that the GOV is simply looking to adapt the U.S. and British oil and gas tax model. While Mommer told Moshiri that the GOV has not yet decided on the ultimate model, Moshiri noted that it is clear that each company asset will be "ring fenced," i.e., ChevronTexaco will no longer be able to discount the losses of its LL-652 project against the gains of its successful Boscan project. Moshiri noted that in the case of the UK, this approach had served to push investment into the future. New investment will be more attractive than putting money into the development of existing assets. -------------- COMMENT -------------- ¶8. (C) At the time of the passage of the Hydrocarbons Law in 2001, GOV officials insisted that company concerns about the failure to grandfather pre-existing contracts were unnecessary because the law could not be applied retroactively. Three years later the position of the GOV is that the Operating Service Agreement contracts were illegal and that "the law" trumps the contracts. In this case, however, application of the "the law" seems to be highly subjective. If the GOV genuninely believes the companies have cheated on their taxes why take the audit back to 2001 and not to the beginning of each contract? The VenEconomy consulting group has also pointed out that the Venzuelan tax code requires that all tax increases be applied in the following tax year, i.e., in 2006. In these circumstances, the conclusion is inescapable that the GOV needs money and will adopt any strategem to get it. McFarland NNNN 2005CARACA01496 - CONFIDENTIAL