OIL & GAS SECTOR KENYA GUIDE BOTSWANA ETHIOPIA KENYA MADAGASCAR MALAWI MAURITIUS NIGERIA RWANDA SUDAN TANZANIA UGANDA ZAMBIA

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1 OIL & GAS SECTOR BOTSWANA ETHIOPIA KENYA MADAGASCAR MALAWI MAURITIUS NIGERIA RWANDA SUDAN TANZANIA UGANDA ZAMBIA KENYA GUIDE

2 Anjarwalla & Khanna ALN Overview A&K is the largest corporate law firm in East Africa and is generally considered the leading full service corporate law firm in Kenya. The firm has offices in the Kenyan business centres of Nairobi and Mombasa. A&K is a member of ALN, an alliance of 12 independent top-tier African Law Firms. A&K works closely with its affiliate offices in Tanzania and the UAE. Areas of Practice Natural resources (including oil and gas), energy, infrastructure, real estate, mergers and acquisitions, capital markets, private equity, corporate and commercial law, competition law, banking and regulatory advisory work, insurance, trusts, tax, aviation, telecommunications, project financing, privatisation law, public procurement, property development, labour and employment, litigation, arbitration and intellectual property. Aln Members BOTSWANA (COLLINS NEWMAN & CO.) ETHIOPIA (MESFIN TAFESSE & S LAW OFFICE) KENYA (ANJARWALLA & KHANNA) MADAGASCAR (MADAGASCAR LAW OFFICES) MALAWI (SAVJANI & CO.) MAURITIUS (BLC ROBERT & S) NIGERIA (G. ELIAS & CO.) RWANDA (K-SOLUTIONS & S) SUDAN (OMER ALI LAW FIRM) TANZANIA (ATZ LAW CHAMBERS) UGANDA (MMAKS ADVOCATES) ZAMBIA (MUSA DUDHIA & CO.) Regional Office UAE (ANJARWALLA COLLINS & HAIDERMOTA) Natural Resources Team SONAL SEJPAL DIRECTOR AMYN MUSSA DOMINIC REBELO DANIEL NGUMY ALEEM THARANI NJERI WAGACHA PRINCIPAL KARIM M. LALJI PRINCIPAL EDWIN BARU PAUL MUTEGI FAYHA KARIMBUX SHEILA NYAYIEKA

3 Introduction This Oil and Gas Guide provides an overview of the upstream Oil and Gas sector in Kenya (the O&G Sector). It provides a useful high level overview to investors and stakeholders of the relevant legal aspects of the O&G Sector, such as applicable legislation currently in place, licensing requirements and applicable fees. Legislation The Constitution of Kenya, 2010 (the Constitution); Petroleum (Exploration and Production) Act, Chapter 308 of the Laws of Kenya (PEPA); Petroleum (Exploration and Production) Regulations, 1984 (the PEPA Regulations) which contain the model form Product Sharing Contract (PSC) which forms the basis of negotiations between oil and gas companies and the Government of Kenya (the Government); Petroleum (Exploration and Production) (Training Fund) Regulations, 2006; and The Ninth Schedule to the Income Tax Act (Chapter 470, Laws of Kenya) (the Ninth Schedule). Other laws which have an impact on the oil and gas sector include: The Land Act, 2012; The Occupational Safety and Health Act, 2007; The Competition Act, 2010; The National Construction Authority Act, 2011; and The Environmental Management and Coordination Act, 1999 (EMCA). Regulatory and Oversight Bodies The governmental and regulatory bodies principally responsible for regulating the O&G Sector in Kenya include: The Ministry of Energy and Petroleum (the Ministry) and The Cabinet Secretary for Energy and Petroleum they represent the Government in matters relating to upstream petroleum operations; The National Oil Corporation of Kenya (NOCK) - a state corporation involved in upstream oil and gas exploration and the Government s nominated contractor under PSCs; The National Land Commission - established by the Constitution of Kenya, 2010 and tasked with the management of public land on behalf of the National Government and County Governments; and The National Environmental Management Authority - established under EMCA to coordinate environmental management activities and the integration of the environmental considerations in development. Entry Requirements and Foreign Investment Approvals Only a company incorporated or registered in Kenya with the requisite financial ability, technical competence and professional skill may enter into a PSC with the Government. There are no foreign investment restrictions specifically applicable to the O&G Sector. However, there are local content and local distribution requirements under the model form PSC and local participation requirements under various laws which would apply to contractors.

4 Licensing Legal Regime The Cabinet Secretary has the power to divide Kenya and its continental shelf into numbered blocks. Kenya currently has 63 exploration blocks after the Cabinet Secretary created 17 new blocks in May The Government may conduct petroleum operations on these blocks either through NOCK or through private contractors under a PSC. While the law allows for the Cabinet Secretary to administer the application and the grant of PSCs, we understand that the Government intends to THE CONSTITUTION OF KENYA, 2010 introduce a competitive bidding system for the new exploration blocks. It should be noted that under Article 71 of the Constitution, the grant of a right or concession by or on behalf of any person, including the national government, to another person for the exploitation of any natural resource requires ratification by Parliament. The Constitution however provides that the provisions of Article 71 shall not come into effect until legislation is passed by Parliament giving effect to Article 71. The legislation setting out the procedure as to how parliamentary ratification may be sought and obtained has been passed by Parliament and is awaiting Presidential assent. Licence Duration The length of the exploration period under a PSC is not prescribed but will usually be divided into an initial exploration period and two additional exploration periods. The licence may be extended for an additional term, upon application, if the contractor has fulfilled its work and expenditure obligations. In the event of a commercial discovery, most PSCs continue for a period of 25 years in respect to the area in which the discovery is made from the date when a development plan for the area is approved. Taxes The Finance Act, 2014 which became effective on 1 January 2015, introduced a new taxation regime for the extractive industry. The Ninth Schedule to the Income Tax Act (the ITA) now governs the taxation of both the O&G Sector and mining in Kenya. The income tax payable on taxable profits by a resident contractor is 30% and 37.5% for a non-resident contractor. The Ninth Schedule also provides for allowable deductions including expenditure relating to exploration, development and decommissioning. It is important to note that the thin capitalization threshold for petroleum companies is a debt-to-equity ratio of 2:1, which would restrict the deductibility of interest against business income to the extent of the thin capitalization. Also, expenditure incurred by a contractor in a contract area can be allowed only against income from that contract area during that year. Tax losses incurred by a contractor can be carried forward indefinitely or until operations cease; while losses from petroleum operations can be carried back as a deduction against income for a period of 3 years. 1 The term permanent establishment is defined in section 2 of the ITA to refer to a fixed place of business and includes a place of management, a branch, an office, a factory, a workshop, and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources, a building site, or a construction or installation project which has existed for six (6) months or more where that person wholly or partly carries on business. A PE can also be created by a dependent agent who is an agent of the [non-resident] person who acts on the [non-resident] person s behalf and who has, and habitually exercises, authority to conclude contracts in the name of that [non-resident] person.

5 Further, sub-contractors without a Permanent Establishment 1 in Kenya are subject to withholding tax of 5.625% of the gross service fee 2 ; while those with a Permanent Establishment are taxed on business profits at a rate of 37.5%. The ITA also requires hedging transactions to be treated as a specified source of income unless the hedging transaction has been approved by the Commissioner and the petroleum contractor has an annual turnover of less than KES 10 million. Pursuant to the provisions of the model form PSC, profit oil is shared between the Government (Government Profit Oil) and the contractor on such ratios as are set out in the relevant PSC. The Ninth Schedule provides, in accordance with the standard provisions of PSCs, that all income tax that a contractor is liable to pay to the Government will be deemed to have been paid as a portion of the Government Profit Oil. However, any taxes due in respect of a gain made on the disposal of an interest in the PSC or any tax that the contractor is liable to deduct from a payment made by the contractor will not be part of this tax deemed to have been paid. The net gain from a farm-out transaction is aggregated into the transferor s taxable income and taxed at the relevant corporation tax rate. The net gain from the disposal of interest in a person, where the interest derives 20% or more of its value from immovable assets in Kenya is taxable. Where the interest derives between 20% and 50% of its value directly or indirectly from the immovable property, the net gain is taxable based on a prescribed formula 3. Further, where the interest derives more than 50% of its value from the immovable property, the whole gain is subject to tax. Such a net gain made anywhere in the world on the direct or indirect disposal of an interest in a contractor is deemed to be income derived or accrued from Kenya and is subject to tax in Kenya. Other Fees Applicable Signature Bonus: This is a one-time payment on award of a PSC, irrespective of success. Its payment may be spread over the life of the contract. Surface Fees: The PEPA Regulations provide that the contractor shall pay an annual surface fee calculated on the basis of the surface area of the contract area and the exploration period. Training Levy: PEPA creates a training fund for the purpose of training Kenyan nationals in petroleum operations. The amount payable by each contractor is specified in the PSC. Proposed Legislation 4 There are a number of proposed laws which will affect the O&G Sector if enacted including: The Petroleum (Exploration, Development and Production) Bill, 2015 (the Petroleum Bill). The Petroleum Bill was passed by Parliament on 4 May 2016 and is currently before the Senate for consideration before receiving Presidential assent. The Petroleum Bill, if enacted, will repeal the PEPA as the new substantive law relating to the O&G Sector. The Petroleum Bill was concurrently published with draft local content regulations and a new model form of PSC (2015 PSC). Among the changes proposed in the 2015 PSC include a new profit sharing model based on profitability as opposed to the daily rate of production in the current PSC. Contractors will also face more obligations as compared to the existing obligations under the current PSC including broader and more stringent local content requirements, additional licenses, decommissioning costs and obligations relating to the protection of the environment; 2 Services by a sub-contractor include geological, geographic and geochemical surveys, aerial mapping, investigations of subsurface geology, drilling services and seismic surveys. 3 The amount of the net gain to be included in income chargeable to tax is computed according to this formula: Net gain * value of interest/total value of inter est 4 As at 20 May 2016

6 The Natural Resources (Classes of Transactions Subject to Ratification) Bill, 2015 (the Natural Resources Bill). The Natural Resources Bill was passed by Parliament on 9 March 2016 and is currently before the Senate for consideration before receiving Presidential assent. The Natural Resources Bill, if enacted, will clarify the transactions requiring Parliamentary ratification under Article 71 of the Constitution. The Natural Resources (Benefit Sharing) Bill, 2014 meant to provide a legislative framework for the establishment and enforcement of a system of benefit sharing in resource exploitation between resource exploiters, the National Government, County Governments and local communities; and The Community Land Bill, 2015 which was passed by Parliament on 21 April 2016 and is currently before the Senate for consideration before receiving Presidential assent. If enacted, the Community Land Bill, 2015 will provide for the recognition, protection, management and administration of community land as defined in the Constitution. This will have an impact on upstream petroleum activities on land which falls within the definition of community land.

7 [A&K] is arguably the strongest firm currently operating in the market [and holds] the title of the largest firm in Kenya. IFLR1000, 2016 Leading corporate practice with a significant track record of handling high-profile M&A and private equity transactions, as well as mandates in the energy, infrastructure and real estate sectors. Especially active regional practice developed through its position as founding member of ALN. Chambers Global, 2016 Contact Sonal Sejpal, Director Anjarwalla & Khanna Head of Natural Resources Group, ALN T: E: ss@africalegalnetwork.com W: