Question:
Grossing up of notional quantities withheld
Entity A is the operator of an oil field that produces 10 million barrels of oil per year. Under the production sharing contract between entity A and the national government, entity A and the government are entitled to 4,000,000 and 6,000,000 barrels of oil, respectively. The production sharing contract includes the following clause:
‘The share of the profit petroleum to which the government is entitled in any calendar year in accordance with the production sharing contract shall be deemed to include a portion representing the corporate income tax imposed upon and due by entity A, and which will be paid directly by the government on behalf of entity A to the appropriate tax authorities.'
Assuming the following facts, how should entity A account for the income tax that it is deemed to have paid in 2013:
• the normal corporate income tax rate in the country in which entity A operates is 40%;
• entity A made a net profit of USD 30 million in 2013; and
• the average oil price during the year was USD 50/barrel.
Gross presentation
Entity A's profit after 40% corporate income tax was USD 30 million. Therefore, its profit before tax would have been USD 50 million (i.e. USD 30 million ÷ (100% - 40%)). In other words, the government is deemed to have paid corporate income tax of USD 20 million on behalf of entity A. Therefore, the government is deemed to have taken 400,000 barrels (i.e. USD 20 million ÷ USD 50/barrel) out of entity A's share of the production. Hence, entity A's share of production before corporate income tax was 4,400,000 barrels (i.e. 4,000,000 barrels + 400,000 barrels).
Net presentation
Under the net presentation approach, entity A ignores the corporate income tax that was deemed to have been paid by the government because it is not a transaction that entity A was party to or because the deemed transaction did not actually take place.