The respondent also cited the ruling of the Internal Revenue Service of the United States, 1967, the US case of Porter v United States, Court of Appeals for the Sixth Circuit (United States), 738 F.2d 731 and the UK case of Tod (Inspector of Taxes) v Mudd [1987] S.T.C. 141. The respondent averred that “it is not possible to treat portions of an undivided interest as separate and distinct interests.”   The respondent submitted that the LIFO accounting method is not only inappropriate but is also not acceptable under International Financial Reporting Standards. S. 40(1) of the ITA requires that a taxpayer’s methods of accounting shall conform to generally accepted standards. International Accounting Standard 2 specifies that “the Standard does not permit the use of the ‘last in first out’ (LIFO) formula to measure the cost of inventories.”

The respondent also cited the case of Minister of National Revenue v Anaconda American Brass Ltd. [1956] A.C. 85 where the application of the LIFO was vitiated in the case.   The respondent contended that the applicants’ argument that “what the parties have agreed to sell must also determine what has been bought and sold for tax purposes” does not hold. Under S. 91 of the ITA, the Commissioner has powers to re-characterise a transaction that was entered into as part of a tax avoidance scheme, or does not have substantial economic effect or does not reflect the substance. The applicants contended that the cost base should be recalculated using either the FIFO method or the averaging method.   As regards incidental expenses, the respondent admitted that it accepted the applicants’ incidental expenditures of US$ 61,903,387 incurred with respect to Heritage interests. However, the respondent asked the Tribunal to exclude those costs.

The respondent contended that S. 89G (d) governs the calculation of the cost base for a subsequent disposal of an interest in a petroleum agreement. Nothing in the Section allows a transferor to increase its cost base in the subsequent disposal by the amount of incidental expenditures.   On issue 3, the respondent submitted that the applicants are not entitled to reinvestment relief. The respondent argued that under S. 54(1) (c) a taxpayer must meet four conditions; (i) the disposal of the asset must be involuntary, (ii) the proceeds from the reinvestment must be reinvested, (iii) the reinvestment must be in an asset of a like kind, and (iv) the reinvestment in an asset of a like kind must be made within one year of the disposal. The respondent contended that the applicants have not met any of the four conditions.

The respondent alleged that the applicants have failed to discharge the burden of proving that the disposal of 16.67% interest was involuntary. Most of the evidence was based on the testimony of Mr. Paul McDade, which was based on his belief. In cross-examination of Mr. McDade, he admitted that there were no correspondences from the GOU. According to Mr. Martin Graham, GOU communicated through meetings, but these were un-minuted. Furthermore, Mr. Martin wrote a letter to the Minister of Energy and Mineral Development where he indicated that Tullow would farmdown at least 50% of their interest. The applicants requested the GOU to approve the creation of a basin-wide partnership where the applicants, CNOOC and Total were holding 33.33% interests each. According to Mr. Rubondo, it was Tullow that decided the award of 33.33% interests to each party. The respondent argued that the case of Uganda Revenue Authority v Bank of Baroda [2007] UGCommC 8 where the court held that the disposal by the bank of its shares was involuntary can be distinguished from the present case. In the said case there was an agreement unlike the current one before the Tribunal.

The respondent submitted that the applicants are not entitled to the reinvestment relief because they did not reinvest the proceeds in an asset of a like kind. The respondent contended that the applicants’ claim that they used the proceeds from the sale of the interests in the PSA to fund pre-existing costs is incorrect. The respondent argued that S. 54(3) of the ITA required that the reinvestment be made in a “replacement asset”. The commonly accepted definition of replacement is “something that replaces”. The respondent claimed that from the evidence adduced the applicants did not use the proceeds from the sale of their interests to acquire new interests. According to the evidence of Mr. Graham, the proceeds from the sale were used to build infrastructure and others. The respondent argued that such expenditure was used to fund obligations under the PSAs that existed prior to the sale. It argued that such use of sale proceeds to fund pre-existing obligations is clearly not an acquisition of a replacement asset as required by S. 54(3) of the ITA.

The respondent cited the US General Counsel Memorandum No. 39572 where it is stated that the reinvestment provision was intended to be a relief provision for a taxpayer to restore its economic position to the prior position. The respondent contended that the applicants by using the sales proceeds to fund their development obligations under the PSAs they are discharging pre-existing debt. This is not an asset of like kind acquired and there is no reinvestment at all. The respondent also argued that the applicant reinvestment was not made within one year of disposal.   The respondent submitted that in the event the Tribunal were to find that the applicants were eligible for reinvestment relief, the relief should be limited to a fraction of the amount to which they claim they are entitled. The involuntary disposal of interests represent 25% of the total interests that the applicants sold (16.67%/66.67% = 25%) which is US$ 41.3 million of the US$ 165 million the applicants claimed have expended on the PSAs.   The respondent prayed that the Tribunal dismisses the application and orders that the applicants pay the outstanding tax liability plus interest.

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