This content is from: Local Insights

Cost recovery in the oil and gas industry

Freddy KaryadiOene Marseille

On December 20 2010, the Indonesian government issued Government Regulation No. 79 of 2010 on Refundable Operating Costs and Income Tax Treatment of Upstream Oil and Natural Gas Businesses which became immediately effective in order to implement Article 31D of the Income Tax Law. This provides further legal certainty with regard to costs in the oil and gas industry that can and cannot be recovered.

The new regulation applies to all upstream oil and natural gas services and production sharing contracts. However, pursuant to Article 38(a), contracts that were signed before the regulation came into force will not be affected. Furthermore, Article 38(b)(8) states that income not generated under production sharing contracts (those in the form of uplift and/or transfer of participating interest) will need to conform with (and therefore be subject to) the new regulation's provisions within a three- month transition period (by March 20 2011).

Under Article 7(1), certain operating costs may be recovered by a contractor when the working area enters commercial production stage. The term operating costs is further elaborated in Article 11. According to Article 12(1), recoverable operating costs are those:

(i) incurred to obtain, collect and maintain earnings in accordance with the prevailing laws and regulations, and directly related to operations in the contractor's working area in Indonesia;

(ii) utilising a fair price that is not influenced by related parties (as defined by the Income Tax Law);

(iii) operated in accordance with the best business and engineering practices; and

(iv) operated in accordance with a work plan and budget that was approved by the head of the Executing Agency, as referred to in Articles 5 and 6.

In addition, there are 24 types of cost that cannot be recovered, as enumerated in Article 13. These include, among others:

  • expenses incurred for personal purposes and/or benefiting families of workers, managers, participating interest holders, and shareholders;
  • administrative and criminal penalties;
  • interest expenses;
  • tax consultant fees;
  • excessive surplus materials due to improper planning and purchasing; and
  • costs incurred before the signing of the contract.

Articles 14 to 20 further elaborate on the technicalities of the costs that can be recovered while Articles 21 to 28 cover the specific details of income and tax calculation. Notably, Article 27(2) imposes a 5% tax on the transfer of interests during the exploration stage, and a 7% tax during the exploitation phase, except for transfers to state-owned enterprises under Article 27(3).

Oene Marseille and Freddy Karyadi

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