GEOL. CROAT. 49/2 171 - 177 ZAGREB 1996 

Professional paper 

Current Trends and Optimal Taxation Arrangements in the 
International Petroleum Industry 

Roger M. NELLIST 

Kc,Y words: Exploration and production of oil and gas, 
Legal, economic and political conditions, Republic 
of Croatia, International participation . 

Abstract 
In order (0 allrael the interest of international oil companies and 

(0 protect Croatia' s legitimate national interests in the opening of this 
key upstream petroleum seCior (exploration Hnd developmellt), a dcli­
!lilian and an international clarification of legal, economic and po liti­
cal conditions is needed, as well as knowledge of lcchnical-gcologic­
exploration characteristics of exploration areas. The need 10 do so, in 
(he eyes of interested imernalional factors, emerges from the incom ­
pl e teness of exi sting legal , and parlly financial regulations, and diffi­
culties in following up their amendments in recent years. Croatia's 
l\,tining Law with s upplemental acts encompasses too broad a range 

o f min e ral resources, especially in the part treating production and 
mark e t. Explanation of ilInbiguities connected to guarantees of 
exploitation rights to the company that has made the discovcry by 
investing the ri sk money, as we ll as removal of anaciJronous obligati ­
on s of the company to participate in flIrt her explorations is necessary. 

On th e other hand, the reponing requirements have to be more 
comprehensive, detailed and rigorous, especially in the definition of 
income and expenditures . Some of the exi sting conditions for joint 
venture s are too " generous", due to the liability of the national oil 
company to cover the production tax, especially in tile areas with 
already establi shed production. Due to the aforementioned, and in 
orde r to exclude som e overcomplicaled production-sharing types of 
arrangement s, a modern fiscal regime for the upstream sector of 
petroleum industry in question is suggested and explained in detail. [n 
thi s fiscal package, the cxisting system is augmented wit h an Addi ­
tional Profit Tax. The government take, thereby automatically grows 
in th e case of s ubswll1ial additional profit. At (he same time, some 
marginally economic field s wou ld pay only revenue taxes at a modest 
rate. A foreign currency fiscal regime specially designed for the oil 
indu stry is al so suggeslCd. The definition and an internationa1 promo­
tion of the role of a national oil company as an independent and 
directly accessible partner of international companies, and as a meet­
ing point of domestic private initiatives that are gaining more impor­
t<llKe is an important politic;11 decision. Solution of this set of condi­
tions would enable Croatia to aggressively implement an effective 
international oil promotion campaign. 

1. INTRODUCTION 

My participation in [his First International Sympo­
sium or Petroleulll Geology has been facilita ted by the 
Croatian Academy or Sciences and Arts, Scientific 
Council for Petroleum, and INA-Naftaplin. In exprcs­
sing my gratitude to the Symposium Programme COIll­
mittec ror their invitation, 1 would like 10 sound a spc-

PROCEEDINGS 

Kljucne rijeci : istrazivanje i proizvodnja nane i plina, 
pravni, ekonomsk i i pol iti cki uvjeti, Republika 
Hrvatska, medunarodno sudjelovanje. 

Saietak 
Radi pobude interesH medunarodnih naftnih kompanija i zastite 

legitimnih hrvatskih nacionalnih in teresa u otvaranjll ovog kljucnog 
dijela naftne industrije (is!fazivanja i proizvodnje) , potrebno je defini­
rati i na medunarodnom planu razjasniti pravne, ekonOlTlske i 
politicke uvjete isto kao i lehnicko- istrazno-geoloske znacajke 
istraznih prost ora. Ovo se namece iz nepotpullosti postojecih zakon­
skih i dijelom financijskih propisa i tdkoca pracenja njihovih nado­
puna posljednjih godina, kako 10 vide zainteresirani cimbenici. 
Hrvatski Zakon a rudarstvu s pratecim aktirna obllhvaea suvisc 
razlicitc mineralnc sirovine, narocito u dijclu njihovog pridobivanja i 
trzista na koje se plasiraju. Nuzn<t su pojasnjcnja dvosmislenosti oko 
garaneije proizvodnih prava kompaniji koja jc dosla do otkrica ula­
ganjcm rizicnih srcdstava, kao i otklanjanje anahonih obveza pro ­
izvodaea da sudjcluje u daljnjim istrazivanjima. 

S drugc strane, zahtjevi 0 izvjcStavnnjll Ircbajll biti razumljiviji, 

ddaljniji i rigorozniji, narociLo u definiranjll prihoda i troskova. Poje­
dini dosadasnji uvjeti zajednickih pothvata moZda su SllVisc "veliko­
dusni", zbog podmirivanja izdvajanja i poreza na proizvodnjll od 
strane nacionalne naftne kompallije, narocito II prostorirna s 
utvrdenom proizvodnjom. Zbog toga, a i zbog izbjegavanja pojedinih 
suvise slozcnih "Production-sharing" tipova ugovora prcdlaze sc i 
detaljno obrazlaze "moderni sistcm izdvajanja poreza" za promatrani 
dio naftne industrije, pri cemu se postojeei sistem nadopunjava dodat­
nim porezom na izdasnije dobiti (APT). Vladina se dobit automatski 
povecava II slucajll znacajnijih dodatnih dobiti od proizvodnje. 
Istovremeno, polja s manjom izdasnoscll placala bi umjerene poreze 
na ostvareni prihod. Predlaze se i us])ostavljanje deviznog rezima 
izdvajanja, posebno podesenog za naftrHl industrijll. Va~,na jc poli­
ticka odluka deriniranje i medunarodna promocija uloge nacionalne 
naftne kompanijc kao samostalnog i izravno pristupacnog partnera 
kako medunarodnih kompanija, tako i okupijalisLa pojedinih inicijati ­
va domaceg privatnog sektora koji dobiva sve veeu va~.nos1. 

RjcSenjem ovoga sklopa prcdllvjcta otvorili bi mogucnost da Hrval­
ska rcalizira agresivnu i cfikasnu kampanju naftne prornocije. 

cial note or thanks to Mr Boro Vlasic and to Mr Slobo­
dan Kolbah of INA, whom have liaised with me closely 
over the last year. 

T should perhaps declare at the oulset !hat I am not 
as knowledgeable about Croatia's petroleum sector his­
tory, exploration potential and exist ing terms as I would 
like to be. Given this, I have chosen to focus my initial 
remarks on the recent trends and practices which we, in 

Commonwealth Secretariat, Marlborough House, Pall Mall, London SW I, United Kingdom. 



172 

the Commollwealth Secretariat, perceive in the interna­
tional petroleum industry, particularly as they relate to 
the attraction of foreign private risk capital for the 
exploration and development of petroleum resources. 
Then, having offered a snapshot of the international 
scene, I would like to share with you some specific 
thoughts about the most appropriate economic and fis­
cal terms and arrangements to apply to upstream petro­
le um operations in this key natural resource sector. 

In seeking to bring international arrangements to 
bear on our deliberations, lei me also highlight my par­
ticular vantage point. It is that or the Commonwealth -
the free association oj" now 53 independent countries 

which in the earlier colonial era were tied with Great 
Britain. These Commonwealth cOllntries arc spread 
arollnd the world - in Africa, Europe, the Caribbean, 
North and Central America, Asia, Australasia and the 
Pacific. Collectively, these countries enjoy a varied and 
orten rich petroleum experience. Thcy range from the 
major oil and gas producers like Australia, Canada, 
India, Malaysia, Nigeria and my own country, the UK, 
to small island States like Grenada, Malta, Seychelles 
and Tonga which, although at present lacking identified 
hydrocarbon resources, are seeking actively to attract a 
share or the explo ration capital of the international oil 
companies. In between these two extremes lie both the 
smaller producers (like Cameroon, New Zealand, Papua 
New Guinea and Trinidad and Tobago) as well as those 
countries (like Ghana, Mozambique, Namibia and Tan­
zania whieh are presently trying to commercialise their 
first hydrocarbon discoveries. This is the perspective 
from which my particular Division in the London-based 
Commonwealth Secretariat extends confidential adviso­
ry services on petroleLlm and mineral sector develop­
ment to Commonwealth mcmber Governments. 

2. INTERNATIONAL TRENDS 

I believe that most informed co mmentators would 
agree that in the last five years or so the international 
petroleum industry has been experiencing some signifi­
cantly changed investment conditions. Many of these 
have resulted directly from changes in the policies and 
terms that Governments are willing to offer the interna­
tional oil companies in order to attract their risk capital 
for exploration and development. And these modifica­
tions to petroleum sector policies and licensing terms 
thcmsclvcs spring from ccrtain rathcr morc fundamcn­
tal global forces - in particular, during the last decade, 
the political changes in the former Soviet Union, East­
ern Europe and elsewhere, and the very definite shift in 
emphasis g lobally in favour of the private sector as the 
prefcrred enginc for future economic growth and 
development. 

Thcse changes have been sufficicntly far -reaching 
that, nowadays, virtually every Government seeking to 
establish cffective policics and terms to attract forcign 
petrol cum exploration capital necds to lake cognisance 
of them. This, 1 would expect, inevitably also includes 

Geologia Croatica 49/2 

Croatia, notwithstanding your own oil and gas produc­
tion and reserves (which are, of coursc, relatively small 
by world standards). Probably, the only Governments 
which can afford to operate for a time in thc facc of 
these changed global conditions, if they so choose, arc 
those of the world's really major oil producing coun­
tries - whose reserves and large national oil corpo ra­
tions give thcm a certain degree of independencc. 

Let me now be more specific. The last few years 
have been characterised by a markedly more pro­
nounced competitive global environment for the explo­
ration and developmcnt risk capital of the international 
oil companies. Many Governments are competing for 
thcsc limited funds. Compared with the 1980's, there is 
a far widcr choicc of explorat ion acreage worldwide for 
lhe oil companies to select, at a time when oil priccs 
(and hence company cash flows available to fund explo­
ration and development) doggedly remain at rclativcly 
unexciting levels. For a start , the countries of the FSU 
and of Eastern Europe are now welcoming forcign oil 
company investment to a much greater extent than ever 
before, although in several of those countries the 
applicable legislation and terms need clarifying and 
refining. Several other examples ean also be quoted of 
countries offering important new exploration and devel­
opment opportunities to the international oil companies 
- Venezuela, Vietnam and China being just some. 

Secondly, some Governments (like that or India) are 
inviting the oil industry to develop existi ng hydrocar­
bon discoveries, whilst others (for example, Barbados, 
lndonesia and Myanmar) arc offering thc companies 
access to on-going production through enhanced oil 
recovery arrangements. All other things bcing equal, 
and compared with explora tion in frontier areas, these 
are opportunities of special interest 10 the companies on 
account of lhe considerably reduced risks and morc ccr­
tain rewards. 

With the global acreage supply/demand balance 
seemingly shifting in favour of the com panics, it is little 
wonder therefore that in many countries these realities 
have already resulted in a more investor-friendly invest ­
ment regime. Tn a classical economic response, the 
"price" of acreage has fallen and, in our Common­
wcalth expcrience, this is reflected in morc flexible leg­
islative and contractual provisions, weaker minimum 
exploration work programmes, and softcr economic and 
fiscal terms. In cach of these responses, it is probably 
true to say that the special characteristics of petroleum 
operations arc also being more adequatcly reflected. 
One general instance is thc emergcnce in numerous 
countries in recent years of more attractive terms for 
frontier and/or deepwater operations. For example, 
Angola, Gabon, Indonesia, Ivory Coast, Malaysia, Mal­
ta, Nigeria, Philippines, Portugal and Thailand arc some 
of the countries which have introduccd in recent years 
concessionary economic and fiscal terms to apply to 
operations in deep water or other frontier areas. 

I would like to cite a few more concrete examples to 
illustrate how some of the licensing tcrm s arc being 



Nelli~l: Current Trend., and Oplim:ll T;lX;uiol1 Arr.mgcmcnts in the lntemalional Pelmlt!um In(!u!)lry 173 

cased . On the legislative side, some countries arc allow­
ing longer exploration periods - for instance, in Gabon, 
Portugal and China, in Angola ror deep water opcra­
tions, and perhaps also in Norway (where there was a 
proposal last yea r for a morc certain ex tended explo­
ration period and for the production period to be 
ex tended to 50 years). Some Governments - ror exam­
pIc, Namibia - have also relaxed earlier limitations on 
the size and conriguration of exploration li ccnce areas. 
Still others arc introducing specific re tention provi­
sions , a[lowin g companies to hold on to di scoveries 
wh ich are not immedia te ly thought to be economic -
this was onc o r the addit ional incentives on offcr to the 
oi l indus try in Namibia 's secondliccnsing round and 
recentl y there we re similar proposa ls in Bolivia and 
Papua New Guinca. As a last exampl e on the legal 
front, several Governments arc relaxing their require­
ments for bank g uarantees to back up the minimum 
work programmes, at [cast in respec t o/" operations 
undertaken by the la rge r we[1 estab li shed oil compa­
nies; Paki stan and again Namibia are two examples that 
come to mind. 

From om Commonwea lth s tandpoint, we are al so 
seei ng more exploration contracts awarded on the basis 
of a minimum work programme commitmcnt compris­
ing only scismic opcrations in the initial phase. Certain­
[y, this is true of contracts covering fronti er exploration 
areas. In a very real sense, though, it seems that th e 
adven t of 3D seismic has helped to bridge the "accept­
ability gap" be tween seismic and wells as rar as many 
Governments are concerned. Where wells are offered 
by compani es as part of their minimum exploration pro­
grammc, these are orten cond ition al on the identifica­
tion of acceptabl e structures in the seism ic; some such 
arrangements do also co ntain back-out provisions 
invo lvi ng a specified payment to Government in the 
event the company docs not actually e lec t to drill. 
There have also been one or two unwelcome instances 
where companies e ither stra ight-forwardly default on 
their earlier drilling commitments or otherwi se seek to 
renegotiate and dcfer those com mitments to a later peri ­
od. 

But it is probably in respect of the applicable eco­
nomic and fi scal terms that the more quant ifiable and 
obvious changes are tak ing place. Many Governments 
arc now offering acreage to !he oil industry under s ig­
nificant ly sorter economic and fi sca l terms than were 
availab[e only a few years ago . Some of the changes arc 
dramati c, but in some extreme cases it is reasonable to 
question just how stable sllch generous concessions are 
likely to be in the long- term. Unusua lly, for a country 
of s llch high petroleum prospectiv ity, the UK has the 
perhaps dub ious distinct ion of hav ing almost the most 
len ient petroleulll fi scal regime in the world; new dis­
coveries there will yield the Brit ish Government only a 
33% share of profit s. Needless to say, a few Govcrn­
ments still demand - and actua[ly still a ttrac t new 
investment under - very tough economic tcrms; almost 
wi thout exception, thesc are the major petro lcum pro-

ducers. In Abu Dhabi , Ind ones ia, Ma laysin, Syria and 
Venezuela, for example, the overall Government Take 
expresses as a percentage of total gross profits appar­
entry lies between about 85% and nearly 100%. The 
range of percentage Govemment Take around the world 
is still therefore very w idc, but there has been so me­
thing o f a downwa rds shift wi thin the range for those 
coun tries which have on ly fro ntier exploration acreage 
or less prospective areas 10 oller. 

It is interesting to note the main ways in which the 
reduction in Government Take is being brought about. 
In the last few years the world has, of course, witnessed 
a general reduction in corporate tax rates, as parL of the 
wider cconomic liberalisation measures adopted by 
many Governments. Income tax rates in the 30-45% 
range are now very common, compared with rat cs o f 
nearer 50% ten or so years ago. In most instances , the 
oil compan ies have benefited from these reductions. 

But many of the 1110re petroleum-specific econom ic 
provisions have also been cased . Perhaps unsurprisi ng­
Iy, the production royalty burden (frequent[y lev ied at a 
[2.5 % ra te a decade or more ago) has been dim inished, 
in several different ways. Those few Governments that 
nrc introducing a petroleum fiscal package con taining 
royalty and tax for the first time are setting the roya lty 
rate a t more modest levels - for example, 9% in the 
ralk land Islands. Some Governments are reducing their 
royalty rates. Some countries (for example, G reece, 
Greenland , Madagascar and Vcnezuela, to name but a 
rew) havc adopted a graduated s liding sca le royalty 
strueture so that lower rates arc paid on low prOduction 
and higher rates on hi gh. In Gabon, there is a royalty 
holiday period for marginal fields. In Pakistan, royalty 
is c reditable against income tax payment s. And, or 
course, a few countries (such as the Netherlands, Nor­
way and the UK) have even abol ished royalties, e ither 
completely or for certain categories of product ion. 

Production sharing te rms have also genera ll y cased 
in favour o f the companies. This includes both a rai si ng 
of the annual ceiling on the amount of production nvni l­
able [or cost recovery, as well as a reduced profit oil 
share for the Slate. Many examples cou ld be ci ted but 
in some cases (for examp le, Malaysia and the Philip­
pines) more fa vourable cost oil lim its a rc avail3ble for 
deep water operations. 

Certain other aspec ts or an economi c and fiscal 
nature also deserve ment ion. Except in the case o/" high­
ly prospec tive acreage, it is probably true to say that 
there is a rcduced emphasis on the lise of (and cert ainly 
the amounts collected through) signature, discovery and 
production bonuses. There is less front-end loading of" 
fi scal burdens and an increasing lendeney for the usc of 
progressive revenue-sharing mechanisms (an important 
trend to which r shall refe r again later). The re is per­
haps also a growing awareness o/" the desirability of 
treating foreign and domesti c investors equal ly, as well 
as public and private investors. And, something by way 
oj" a contrary impact , Tax Administrations arc paying 
more a llenlioll to trans rcr pric ing concerns and to 



174 

enforcing compliance and reporting requirements; in a 
similar vein, antiquated deductions such as depIction 

allowances arc being withdrawn and rules are being 

adopted to prevent thin capitalisation practices. These 
latter actions arc all designed to ensure a morc rational 

and fair tax base which, of course, partially offsets the 

reductions in tax rates. 
Significantly \00, many 1110rc of the economic and 

fiscal terms contain biddable and negotiable e lements. 

Scope may be g iven for this in govern ing legislation -

slIch as the need to agree with investors the top two 
rates or Additiona l Profits Tax in Nami bia - or morc 

orten, in the case of production sharing arrangements, 

some or all or a Government's preferred parameter val­
ues are set out in its Model Petroleum Agreement but 

the actual cost oil and profit oil percentages are negot i­

ated and agreed with investors on a case by case basis: 

Indi a is one of many countries that follows this 
approach. Orten, the same goes for participation levels 

and , occasionally too, royalty . The added degree of 

flexibi lity inherent in this negot iations approach is not 

at all surprising in the present oil industry investme nt 

climate. 

There is one final point I would like to make regard­
ing international trends and practices, and that concerns 

the apparently diminishing ro le of State participation. 

This is, of course, consis tent with the increased empha­

sis being placed more generally on the contribution to 

be made by the private sec tor. Thus, we learn that Bar­
bados, F inland , Hungary and India arc among the 

nume rou s coun tries worldwide that are partially pri ­

vatisi ng their national oil companies. In many other 
countries, recent licensing rounds have proceeded on 

the basis of a reduced participation interest by the S tate 

- for example, in Colombia for small fields, in Philip­

pines for deep waleI' operations, in Pakistan for less 

prospective acreage, and in Gabon, Greenland, Nether­

lands and Tanzania for all new licences. In still other 

countries the requirement for any level of State partici­
pation has apparently been removed completely - for 

example, in New Zealand, Peru, Seychelles and 

Trinidad. And in the instance of those few countries 
such as the Falklands and Namibia which are perhaps 

fortunate enough to be commencing their petroleum 

sector arrangements from scratch, there is no mandato­

ry requirement for State participation. 
Clearly then, the petroleum world is moving on. 

And Governments which arc now seeking to increase 
the involvement of private and foreign oil companies in 

the furthcr development of their national petrolcum 
resources, including (as I understand it) Croatia, will 

need to lake heed of thesc trends and developments in 

the international scene if they a rc to successfully 

achieve their objectives. 

Gcologin Croatica 49/2 

3. DESIRAIlLE CHARACTERISTICS OF AN 
ECONOMIC AND FISCAL REGIME 

Let me now turn to a more detailed consideration of 
the principal economic and fiscal terms appropriate to 
upstream petroleum operations. Apart from the actual 
or perceived petrolcum prospectiv i ty of a country or 
area, the economic and taxation terms imposed by Gov­
ernments are of paramount importance in determin ing 
the interest or otherwise of the multinational oil compa­
nies in seeking exploration ac reage. (An appropriate 
legislative and, usually, con tractual framework is also, 
of course, necessary). The economic and fi scal terms 
determine the balance between the inevitable risks and 
the hoped-for rewards associated with all petroleum 
operations; they may make or break a deal between an 
oil investor and a Governmenl. It almost goes without 
saying that examples can be cited of both "good" and 
" bad" petroleum fiscal regimes, and I wou ld like now 
to outline what I believe are the desirable, if not essen­
tial, characteristics of an economic and fisca l package 
for upstream petroleum operations. 

A mode rn petrol eum economic and taxation pack­
age should be designed to achieve severa l e nds. Obvi ­
ously, it must s imultaneously satisfy the critical 
requirements of Governments as well as thosc of 
investors. In very broad terms, Governments will wish 
to ensure that, whilst yielding them an acccptable level 
and pattern of tax and other receipts, preferably at no or 

minimal direct cost to the State, the package attracts an 
adequate level of investment on a recurring basis and 
sustains a reasonable level of petroleum sector activity. 
From the investors' standpoint, the fiscal regime shou ld 
allow the companies to fully recover their outlays, as 
quickly as possible, and allow them to retain an ade­
quate level of profits; the oil companies also strongl y 
prefer the taxation terms to be known in advance and to 
remain stable throughout the life of thei r petroleum 
operations. 

These seemingly eonJlicting objectives can in fact 
be reconcil ed successfu lly if the fiscal package is care­
fully constructed. What then should be the principles 
upon which such a package is formulated. 

I would suggest that the economic and fi scal regime 
should be straight-forward in design and transparent in 
application. (This cases understanding, negotiation and 
administration). Whilst containing some in-built flexi­
bility, it should involve the exercise of minimal Gov­
ernment discretion ex-post. It should be neutral in effect 
(creating no distortions) and encourage maximum effi­
ciency in operations. It should be predictable in its 
impact. It should yield Government at all times during 
the production phase some minimum level of "Take", 
but allow the companies to recover their costs quickly. 
The bulk of the Government's Take shou ld a rise 
through taxes and other revenuc-raising mechani sms 
based on profits, and probably also on profitability. In 
fact, in exchange for "front-end" relie f (g ranted, for 
c xamplc, by import duty concessions, modest royalty 



Nellisl: Currcm Tre uds ;lIld Optimal Tax;lIion Arr:lIlgemcms in the Imem;llion;iI Pt:lroleurn I ndu~l ry 175 

rates and accelerated depreciation for tax purposes), the 
tax pac kage can be struclUred so as LO enable the Gov­
ernment 's Take to build lip fairly quickly afte r the point 
of cos t recovery and then ri se, in a progress ive manner, 
still further as the overall level or rate of project prof­
itabilit y inc reases . The possibilit y for tax leakages, 
e ith e r dom esti call y or internationally, should a lso be 
minimi sed ; in this regard, we can not e in pass ing that 
supposed concessions like tax holidays are ineffi c ient 
and probably ineffective. 

There arc numerous cxamples worldwide of specia l 
pc trol eum economic and fi scal packages which re Jlec t 
most, if not ali, of these principles. Such fi scal arrange­
ments arc balanced and fair to both companies and host 
Governments, in both the short and the long- tenn ; they 
the reby lay the economic fra mework for a stable work­
ing re lationship between the part ies tha t may endu re for 
several decades. 

4. PROGRESSIVE REVENUE-SHA RING 
MECHANISMS 

It is sometimes argued that progressivity is one of 
the key features of such fiscal regimes which make for 
grea te r stabil ity in the inves tor-Governmen t re lation­
ship. Ce rt ai nly , from our standpoint, progress ive rev­
enu e-s harin g mechani sms seem to be featurin g more 
o ft en in pe tro leum eco nomic and fiscal arrangement s. 
Let me say a few more words on this particular topic. 

A pe troleum fi scal reg ime is said to be progress ive 
if it yie lds for Government a higher percentage share of 
field- life pre- tax profits from any very profitable devel­
o pments than it docs from any developments of more 
modest profitabi lity. Under such a scheme, the Govern­
ment 's share will be low on any marginal developments 
- thi s he lping to ensure the ir commercia lisation in the 
first place - but will be increasingly greater the more 
attrac ti ve is the petroleum project. A high Government 
share from any hi ghly profitable operations is the quid 
pro quo ror the more lenient tax treatment of develop­
ments o r more modest profitability. fn order to generate 
this progress ivc enccl overall , at least one of the spec i­
fi c re venue- rai sing e lements in the fiscal regime must 
be linked to some measure of project projirabiliry, and 
not just thc quantum of profits. Us ually, the profitabi ­
lity meas ure selec ted is e ither a rate of re turn or the 
investment multiple (sometimes also called the "R-fac­
to r"). In prac tice, the two most common revenue-shar­
ing mechanisms which have been adapted and adopted 
in thi s way a rc the additiona l profi ts tax (wh ich a lso 
goes by many other names, such as resource rent tax) 
and produc ti on sharing arrangements. Occasionall y, 
though, royalti es, State participation and even , excep­
tiona]!y, income tax, have bcen made progress ive. 

Many examples can be quoted of each. A survey I 
conducted in 1993 concluded that about one country in 
e ight had incorporated progressive revenue-shar ing 
mechani sms in their petroleum regim es. Since then, 
even more co untries have adopted them. Some of the 

leadi ng examples of the rate of re turn based additional 
profit s taxes are : Aus tralia , Namibi a and Papu a New 
Guinea; 1 understand that Poland and Kazakhstan have 
also recent ly adopted th is fo rm of laX. Algeria , Angola, 
Ghana, India, Malta, Qatar and Zambi a arc just some or 
the countries that have linked the ir producti on shares to 
a rate of return or R-factor. And to quot e just one other 
examp le, Tunisia has a graduated sliding scal e of both 
royalty and income tax ratcs where the rcspcctive rates 
of levy are determined by the R-factor. 

5. ONE POSSIBLE OPTIMAL TAXATION 
PACKAGE 

In turning to the concluding sec tion of my presenta­
tion , I would like to propose a possible optimal taxation 
package for the upstream pe trole um sec to r. There is 
noth ing te rr ibly revolutionary about it , and no doubt 
some people will maintai n that tax at ion can neve r be 
opt imal! But laxat ion is, and seemi ngly a lways has 
been, an inev itable pa rt of life . Two thousa nd years 
ago, as told by Saini Luke in the Bibl e: " ... Ihere weill 
out a decree from Caesar Augustl/s, lhat aft fhe lVorld 
shollid be taxed ... .. . alld all well! to be taxed. every aile 
iI/to his OWl/ city". 

The fisca l package which f am about to outli ne 
exhibits the desi rable characteri stics J referred to in sec­
tion 3. It can achieve the broad obj ectives, and satis fy 
the minimum requirements of Governm ent s and 
investors, which I also brie n y alluded to. 

Thi s fiscal regi me comprises an ad-va lorem royalty, 
a modern petroleum income tax and a multi -tie r Add i­
tional Profi ts Tax. State pa rti c ipati o n ean also be 
accommodated , if necessary. T hese a re the principa l 
components . 1 wou ld a lso ex pect annual a rea rental 
charges to be levied. But duti es and sal es taxes on 
imported and exported items necessarily and exclusive­
ly required for the petroleum operations should be min­
imi sed and, at least d ur ing the ex plora ti on phase, 
preferably not be lev ied at al l. (Thi s reduccs the front ­
end costs of the compani es an d helps to ensure tha t 
every $ they spend in the cou ntry is devoted 10 physical 
exploration work per sc). The right of a fore ign party to 
export it s petroleum produced , to have unfe ttered 
access to the foreign exchange proceeds generated, to 
be able to repatriate its profi ts freely, and for the petro­
leum produced to be va lued for royalty and tax purpo­
ses at fa ir intcrnational marke t prices, should all be part 
o f the overall econom ic and fiscal package too. 

Le t met now ou tline in turn each to the princ ipal 
componenls of this package, beginn ing wi th royalty. 

Royalt y should be imposed on an ad-valorem basis, 
and at a modest rate , on the value of o il and gas pro­
duced. It should be payab le all entities in the licence. 
This will yie ld at a ll times during thc produc ti on phase 
an appropriate minim um level of Take for Govern men t 
- thcreby satisfying political as well as econom ic objec­
tives as the petroleu m (a key non -re newable natural 
resource) is exhausted. However, to prov ide for even 



176 

greate r fl ex ibility, the Minister should be author ised to 
wai ve, de fc r or reduce the payme nt of royalty in c ir­
CUlll s tances whe n to clo so is like ly to maximi se the 
recovery or hydrocarbo ns from a particular fi e ld in a 
g iven time pe riod , for example, on marginal opera tions 
durin g fi e ld produc ti on dec line . If Ihe Gove rnme nt 
wi shes to gain access to oil gas resources direc tl y, there 
could al so be a provi s ion requiring the royal ty \0 be 
paiel in kind. 

The second c lement in the fi scal package is a spe­
c iall y rormulat ed Petroleum Income Tax (P IT), with 
de tailed provisions tailored to suit the unique character­
istics o r the oil and gas industry. The PIT rate should be 
es tabli shed some whe re in the 30% to 40% range 
(de pend ing at what rates the other clements in the pack­
age arc sct at ) and lev icd in a non-discrimi natory man­
ncr. In o rde r to accele rate cost recove ry by the inves t­
ing oi l compa ni es, qual ify ing project expenditures 
should be depreciated over a shon time pe riod: immedi­
ate w rite-o lT in fu ll would be appropriate for ex plo­
rati on (and , of course, operating) expenditures, whi ls t 
development expenditures could be allowed ove r a 3, 4 
or pe rhaps 5 year period. In the computation of PIT, 
royalt y would be an allowable deduction and losses 
should be pe rmitt ed to be carried forward without 
res tri c ti on. PIT should be assessed on a company by 
company basis, meaning that would be no narrow ring­
fe nc ing - thus providing some additional incentive for 
furthe r ex pl oration and development within the country. 

Ord inaril y, it cou ld be expected that the bulk o r a Gov­
e rnment's Take from pe troleum operations would arise 
thro ugh th is PIT. Ghana, Namibia, Papua New Guinea 
and Seyche lles arc examples of some o f the coun tries 
wh ich have adopted mode rn PIT rules along the lines 
sugges ted he re. 

A lllulti -ti c r Add itional Profits Tax (APT) would 
constitute the third (and often last ) princ ipal clement in 
the ri scal package. Royalty and PIT would be allowabl e 
deduc tions in the computation of this cash-now based 
tax , whi ch would only be paid in the event or, and in 
respect or, more profitable operations. Probably trig­
gered by an after-tax rate of return (which cou ld a lso be 
inrlati o n- indexcd , to give the investor added prot cc ­
ti on) , a multi -ti er APT structurc wou ld injec t an eve n 
great e r deg ree of prog ressivity into the overa ll fi seal 
package than a s ing le- tier APT. (Tn practice, two o r 
three tie rs should be sufficient). As with the thresholds 
tilat trigger it, some or all of the APT tax rates could be 
negotiable on a case by case basis with each investor, 
the re by effec tive ly de termining the max imum marginal 
rate o f to ta l Government Take on the basis of the per­
ce ived charac te ri s tics or each licence area. Tt mi ght be 
appropri<lt e to ring-fence the APT more narrowly than 
the P IT in orde r to lend balance to the ti ming and pro­
ri le of the Gove rnment's Take. An option could al so be 
included ror the Government to take the APT in kind, if 
access to physical quan tities of oil and gas is des ired. 

If necessary , it wou ld also be possibl e for some 
form of S lat e participation to be included withi n this 

Geolog ia Croalic;l 49n 

fi scal package. Obviously, though, the royalty, PIT and 
APT rates wou ld have to be established and/o r negotiat ­
ed bearing in mind the nature and extent of the partic i­
pation component. 

The outlined fiscal packa ge is a workable " main ­
s tream " one, in the sense that by and la rge somc thing 
similar to it is adopted by about half of the cOllntries in 
the world today. To a greate r or lessc r ext cnt, it is 
embraced by both small and large countries; by c urrent 
produce rs, presently non -producers and for frontier 
acreage; and by both developed and less-developed 
countries. This package is mocie rn , strai ght -forward in 
des ign and relatively easy to administe r. It is llexibl e in 
impact, au tomatically adjusting the ac tual fi scal burden 
to the intrinsic profitability of the part ic ular pe troleum 
ope rations. Companies can recover the ir costs qu ickl y 
and onl y the n wi ll the Gove rnm e nt 's Take bui ld up. 
Assuming appropr iat e rates for the roya lt y, PIT and 
APT, it is inte rna ti on a ll y co mpe titi ve and the PIT 
should be a creditable tax fo r fore ign o il compan ies in 
the ir home jurisdictions. It pu ts all parti c ipant s in the 
venture on an equal footing and is equally applicabl e to 
oil and gas. It can be so s truc tured that othe r important 
national object ives can be sati s ri cd simultaneously if 
desired - such as direct access to oil and g[lS production, 
anci a ro le for State participation. 

I have deliberatcly shyed-away from ac tually rec­
omme nding that this particular ri scal package should bc 
adopted by Croatia, although 1 be lieve it would in fac t 

be qui te appropriate he re, too. In prac tice , each cco­
nomic and fi scal regime must be tailored to address and 
re fl ect the part ic ular c ircumstances of each country. In 
this regard , I am aware that, at leas t in the recent pas t, 
Croa ti a has expressed a pre fe re nce for cost-recove ry 
production sharing arrangements. My unde rstanciing is 
tha t, unde r these arrangeme nts, lNA-Na rtap lin assumes 
a 50% State interes t - a ve ry large int e res t - from the 
deve lopment stage (perhaps uncl e I' carri ed int eres t 
te rms) and that the foreign part ies' tax li a bility is sati s­
fied out of the State's share of Profit Oil. The /orl7l of 
Croat ian Take is the refore qui le diffe rent 10 that which 
wou ld accrue to a Governme n t und e r the roya lty and 
tax -bascd fiscal package I have just outlined; al so , 
except with respcct to the phys ical produc tion rates, the 
ove ra ll economic impac t or the present C roatian te rms 
cannot be progress ive. 

Presumably, there a re speci fi c reasons why C roatia 
has dec ided to pursue wha t, in our vie w in the Com­
monwealth Secretariat, arc the more complicat ed pro­
duction sharing arrangeme nts . Howeve r, even within a 
production sharing format , ma ny of the desirable char­
acteristics of a fisca l package which I describcd earl ier 
can be accom modated , and Croatian auth oriti es may 
pe rhaps wish to rcvisit th ese . As one final point of 
information on th is matter, 1 would s imply li ke to br ing 
to the atten tion one of the main conc lusions of the Lon­
don -based Pe troconsultant s ' 1996 Annual Review of 
110 Pe troleum Fi sca l Regimes, name ly, th e apparel1l 
trend during the last two years away from produc tion 



Nellist: Curre nt Tn;lld~ ,md Opt ima l Tax ation Armngell l ell1~ illlhc Internati onal I\;trolcum Industry 177 

sharing contracts towards a royalty/tax structure. To 
quote from the Executive Summary of Petroconsul ­
tants' recenlly publi shed Review: 

"The cflallge ill P,ollll7llin to a royalty/tax syste lll 
reflects aile of tfle IIInill trellas ill fiscal regil1les aI/ring 
the last two years - /lotahly ill Lat/II Alllerica alld East­
em Europe - fhis type of fiscal regillle. ProrillctiOIl sllnr­
illg COli till lies to nominate ill tfle Nliddle Enst, CIS alld 
Far Eas/: alU/Ough ill VietnalJl, for exalllple, tlle PSCs 
nre beillS IllOriifieri so till/I Ihelj a/so illclllrie roljaltlj allri 
tax elelllellts." 

6. CONCLUDING REMARKS 

In bringing this present ation to a close, r must 
acknowledge that 1 have necessarily been rather selec­
tive. T have concentrated on the principal economic and 
fiscal terms which have a direct bearing on the divis ion 
of upstream petroleum project profits between a host 
Government and a private sector investor. Of course, 
traditionally, petroleum arrangements wit h foreign 
investors also embrace several other telms with an eeo-

nomic impact - such as licence area rentals, minimum 
annua l training expenditure commitments and mini ­
mum exploration expenditure commitments. There are 
also important provisions with respect to forei gn 
exchange entitlements, val uation of petroleum, account­
ing rules, bank and performance guarantees etc. 1 have 
ignored all or these other mallers, either because they 
are of a secondary monetary magnitude or because they 
arc of a ditTercnt nature in the overall schcme or things. 
Equall y, T have not sought to comment on the potential­
ly significant indirect economic benefits which petrole­
um operations can generate - such as employment cre­
at ion, the impetus for regional development, encourage­
ment for the further development of related service 
industries etc. 

1 hope my remarks have been of interest. Attracting 
private (and especially fore ign) exploration capital to a 
particular host country is a time-consuming, challeng­
ing and orten complex exercise, requiring a multi-disci­
plinary approach in which the geological, economic and 
legal considerations arc successfully blended. I wish 
Croatia well in your future petrol eum exp loration , 
development and production endeavours. 



Geologia Croatiea 49/2