Withdrawal of appeal against new tax puts Petronas on the back foot

KUALA LUMPUR (June 24): Petroliam Nasional Bhd (Petronas) will withdraw its legal action against the 5% petroleum product sales tax imposed by the Sarawak state government by Aug 3, as part of a wider agreement announced in May on future management of the state’s oil and gas (O&G) assets.

With the undertaking, Petronas is seen as opening the floodgates to similar claims by other states. It also raises the question about Petronas’ future control over the nation’s O&G assets under the Petroleum Development Act (PDA 1974).

The latest development comes at a time when the Perikatan National federal administration — also Petronas’ sole shareholder — is working hard to consolidate support in the Dewan Rakyat ahead of a no-confidence vote due next month.

Support is critical from Sarawak, which has the biggest say in Parliament among all states with 31 out of 222 seats.

As for Sarawak, whoever can finally bring an end to its 40-year long battle with the federal government for more control over its O&G assets is sure to garner more support during the state elections due next year.

From a legal action to a compromise

The episode began with Sarawak imposing the additional 5% tax on all petroleum products in the state starting January 2019.

This came as a surprise, considering Sarawak, together with Sabah, was at the time discussing with then federal government Pakatan Harapan on their share of oil revenue under the Malaysian Agreement 1963.

When Petronas did not pay the tax, Sarawak filed a RM1.3 billion civil suit against the national oil firm.

At the time, Petronas was adamant that the sales tax was not valid because the matter appears under the Federal List and cannot be double-taxed. Petronas already pays tax to Putrajaya in the form of petroleum income tax.

It also appears to overlap with PDA 1974, which states that Petronas is the regulator of all O&G assets in the country.

As there is no legal precedent on the matter, outgoing Petronas president and group CEO Tan Sri Wan Zulkiflee Wan Ariffin had planned to let the court decide on the matter once and for all.

Hence, Petronas applied for a judicial review to declare the tax as null and void. But the application was dismissed in the Kuching High Court on grounds that the tax is legitimate. Petronas then filed an appeal against the decision.

At this juncture, it welcomed a new shareholder in the form of the Perikatan Nasional coalition, which took over control of the federal government from Pakatan Harapan in February.

Since then, both sides of the political divide have been lobbying hard to secure the elusive simple majority support of 112 MPs in the Dewan Rakyat, ahead of the sitting next month.

Should Petronas really withdraw the appeal, it is expected to appease Sarawak’s ruling coalition Gabungan Parti Sarawak (GPS), which currently has 18 MPs in the Dewan Rakyat.

Yesterday, Petronas counsel Datuk Malik Imtiaz Sarwar said the company will withdraw the appeal by Aug 3, pending the finalisation of an agreement between Petronas and Sarawak.

The agreement is referred to in a joint statement between Petronas and Sarawak on May 8, when Sarawak agreed to acknowledge Petronas as the industry regulator in the country under PDA 1974, while Petronas agreed to pay the sales tax — which both parties also agreed will be lower and staggered in the future.

Far more than just RM2 bil each year

Petronas, being Malaysia’s sole Fortune 500 company, has the financial muscle to absorb the initial sales tax.

However, the compromise will chip away its future control over the O&G portfolio — both financially and operationally.

Already, fellow East Malaysian state Sabah has imposed a similar 5% petroleum products sales tax that will take effect this month, which is estimated to rake in about RM600 million for the state this year.

Sarawak is Malaysia’s biggest natural gas producer with 61% of the nation’s total production. It also produces 26% of the country’s crude oil and condensates.

Sabah, on the other hand, is the leading producer of the country’s crude oil and condensates at 41%. It also contributes 13% of the nation’s natural gas production.

Some quarters have commented that the sales taxes imposed by Sabah and Sarawak do not hinge on the Malaysian Agreement 1963, which means that other oil-producing states like Terengganu could also enact similar state law for the tax.

If that’s the case, the financial burden could escalate for Petronas.

Currently, the sales tax is imposed on both Petronas and production sharing contractors (PSCs). In Sarawak’s case, the total is estimated at RM3.9 billion for 2019, with around RM2 billion from Petronas alone.

However, industry experts said a clause in the production-sharing contracts allows the PSCs to claim the additional 5% tax payment from Petronas.

Meanwhile, some companies have adhered to the new state law and paid the tax since last year to avoid facing immigration and licensing hurdles, which could hurt their entire operations.

Hence, withdrawing opposition to the sales tax law will open the floodgates for more claims against Petronas by the PSCs.

Including Sabah’s sales tax, this means Petronas would bear the burden of the entire RM4.5 billion — representing around 11.12% of its RM40.47 billion net profit for the financial year ended Dec 31, 2019 (FY19).

In the past, Petronas has said that out of each barrel of oil, it can only keep an average of 3.7% of the gross revenue under the production sharing contracts.

Around 10% is earmarked for oil royalty (5% each for state and federal governments), petroleum income tax (7.6%), and PSCs (8.7%), while the biggest portion of all goes to costs (70%).

A lawyer told theedgemarkets.com that the withdrawal of the appeal means that Petronas accepts the decision by the High Court, and that the High Court’s decision will be final.

If Petronas withdraws the appeal, it will have to face the music alone.

In the meantime, its other stakeholders are not going to be giving up their share, especially Putrajaya — whose share of royalty, tax, and dividends from Petronas accounts for 20% of federal government revenue — considering the nation’s fiscal position and the economic headwinds ahead.

Source: TheEdgeMarkets