Economic Diversification and Growth

Chapter 3
can have a negative impact on the country’s fiscal position
and development program.
3.11. Once oil investment enters Uganda, the tax system
should be ready to ensure that the revenue benefits are
retained (by reducing the risk of leakage through international
tax planning and profit shifting). These practices
are a threat to revenue mobilization, not only from multinational
petroleum companies, pipeline companies or their
international subcontractors, but also from cross-border
flows across all sectors. Through aggressive transfer pricing,
thin capitalization, deductible costs against tax liabilities
and inter-company payments of interest and dividends
at favorable rates, multinational companies can reduce their
overall liability globally. In developing countries, the profits
of large international petroleum companies will be at risk
of cross-border leakage, undermining the country’s revenue
mobilization efforts.
3.12. Consequently, Uganda needs to review its Double
Tax Agreements (DTAs), strengthen its capacity
to identify and enforce anti-avoidance provisions and
also strengthen its audit capacity. Uganda’s tax laws and
regulations were improved to provide for treatment and
documentation of transfer pricing and include a general
anti-avoidance clause, but more can be done to strengthen
the legal framework and its enforcement. For example, the
national budget for FY2014/15 proposes to strengthen the
thin capitalization rule, which reduces the scope for deducing
interest on inter-company loans or for more sophisticated
mechanisms coming from non-associated entities. The
use of UN provisions (on the basis of the model tax treaty)
for future negotiations may also help Uganda capture a
greater share of the value of activity sourced in Uganda. The
government also plans to invest in tax administration, particularly
in specialized audit and transfer pricing investigation.
3.13. The use of oil resources and the selection of appropriate
public investment policies are also critical to maximize
economic and social benefits. This issue will be
addressed in Chapter 4 in the context of discussions regarding
long-term sustainability.
D. Encouraging linkages through realistic
Local Content policies
3.14. The government should include in its oil contracts
provisions to ensure that oil companies support the
country’s socio economic development i.e. use local suppliers,
provide training, develop local skills, give priority
to Ugandan citizens and create enterprise centers. Oil
companies should also organize local participation in decision
making and ensure that the indigenous communities are
adequately compensated to avoid further complications that
could affect national interests.
3.15. Local Content Policies (LCPs) are government
interventions aimed at increasing the share of employment
or sales that is supplied locally at each stage of
the value chain. To be effective, the design of LCPs must
ensure that requirements are commensurate with existing
and future local supply capability and the life of the petroleum
sector. Incorrectly designed LCPs can encourage
unproductive practices, higher costs, lower quality, restricted
competition, and longer timeframe for the completion of
tasks. LCPs need to be used with caution and be backed by
solid analysis. LCPs are concerned not only with an immediate
expansion in local content 4 (for example, the percentage
of local employment in the sector), but also with actions
that will lead to longer-term development, including the provision
of training for the local labor force or the promotion
of business development skills for local suppliers.
3.16. It is critical for policy-makers to facilitate the development
of competitive, capable, and sustainable local
skills and supply industries, rather than simply drive an
increased share of local content. Given the relatively low
level of direct employment in the exploration and production
(E&P) of oil and gas, the development of domestic suppliers
is one of the possible benefits of petroleum exploitation.
Most petroleum codes and contracts require that the holders
of petroleum E&P rights give some preference to domestic
goods and services. Policies for local sourcing fall into three
broad categories: setting of local content targets, specifying
a margin of preference for domestic suppliers, and adjusting
the process of contract award and execution to benefit
local suppliers. The development of local capacity needs to
be addressed alongside these policies. A number of countries
established comprehensive local content development
programs through the creation of enterprises development
centers and other initiatives.
3.17. When designing LCPs, it is important to recognize
that policy instruments used to address general market
failures are different from those used to promote specific
sectors. The government could be interested in horizontal
interventions (support to specific activities: R&D, training,
4. Local content can refer to jobs or value added anywhere in the domestic economy
as a result of the action of an oil and gas company, or it can more narrowly
refer to activity created in the specific locality of the oil fields. Local content can
also refer to the provision of infrastructure that is intended to benefit the local
population.
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Uganda Country Economic Memorandum: Economic Diversification and Growth in the Era of Oil and Volatility