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)

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SUMMARY
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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.

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TAX AUDITS
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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.

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TAX CHEATS?
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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.

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INDUSTRY TAX STRUCTURE IN FLUX
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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.

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COMMENT
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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


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2005CARACA01496 - CONFIDENTIAL