Indonesian Insights

Written by Syahdan Z. Aziz

In 2011, the two major legal developments affecting the oil and gas industry included ongoing discussions of Government Regulation No. 79 as well as steps toward drafting a new Oil & Gas Law in Parliament.

Government Regulation No. 79

In late 2010, the Government of Indonesia issued Government Regulation No. 79 of 2010 on operating costs that can be recovered and the income tax treatment of the upstream oil and natural gas business sector (“GR 79”). This regulation was enacted in order to implement Article 31D of the Indonesian Income Tax Law.

GR 79 sets forth and clarifies, among others, 24 types of costs that cannot be recovered, the recovery of operating costs, the calculation of income tax on income associated with PSCs, service contracts and other income outside of PSCs, as well as provides additional authority and responsibility to the Minister of Energy and Mineral Resources (“MEMR”).

In addition to the foregoing, GR 79 stipulates a form of contract sanctity for existing PSCs that were signed before GR 79 was enacted. However, it also provides that matters that have not been regulated in Production Sharing Contracts (“PSCs”) must be adjusted to comply with GR 79 within three months (i.e., March 20, 2011).

This regulation was expected to encourage investment in the upstream oil and gas sector in Indonesia, but in practice some provisions of GR 79 created uncertainties for existing PSCs.  Implementing regulations for GR 79 were also supposed to be issued, which unfortunately have not yet been issued to implement and compensate for the ambiguity created by GR 79.

Faced with uncertainties created by GR 79 towards PSC contractors, the Indonesian Petroleum Association (“IPA”) submitted a petition to the Supreme Court for the judicial review of GR 79.  In its petition, the IPA requested that GR 79 be revoked or, at a minimum, identified 20 articles of GR 79 to be revoked.

One of the articles that was requested to be revoked is the obligation of existing PSCs to comply with GR 79.  Even though the spirit of this regulation is to adhere to the sanctity of contract principle, this specific article is contrary to sanctity of contract in practice and causes GR 79 to be applicable retroactively.  Such provision created a degree of uncertainty to existing PSCs since they must adjust and set forth certain items, such as the amount of state revenue and non-recoverable operating costs that was not agreed upon in existing PSCs.

Another matter that was viewed as unusual and uncertain is the income tax payment mechanism where income tax can be paid by the PSC contractors in-kind.  Payment for oil and/or gas in a typical Indonesian PSC is in United States Dollars, while the calculation of tax is based on Indonesian Rupiah.  This can result in currency differences on the tax calculation that can raise tax payment disputes.  GR 79 is also unclear as to which governmental body is authorized to receive the tax that is paid in-kind.  For example, the Directorate General of Taxation can only receive tax payment in the form of money and BP Migas has no authority over taxation.

GR 79 also attempts to impose indirect taxation on the transfer of participating interest occurring overseas, which is beyond the jurisdiction of the Republic of Indonesia.

The petition that was submitted to the Supreme Court by the IPA was rejected in October 2011, and the legal basis for their decision has yet to be clarified. However, with this decision, GR 79 is in full effect. While the implications of this decision remain to be seen, oil and gas companies may continue to be more precautious in investing in Indonesia.

Draft Law Initiative

After being enacted ten years ago, the Government is now in the process of drafting a new oil and gas law to replace the existing Law No. 22 of 2001 regarding Oil and Natural Gas (the “Oil and Gas law”).  Among others, the new draft oil and gas law is initiated to affirm the division of governmental authorities, to shift pure liberalization to nationalist liberalization, and to affirm the application of the lex specialist principle embedded in cooperation contracts.

Among the proposed changes intended in the draft, a new governmental body is planned to be established by law, called the Development Body, to enter into cooperation contracts with business entities and/or Permanent Establishments in replacement of BP Migas.  The existence of the Development Body will in some sense reduce the role of BP Migas as the implementing body.

The draft oil and gas law will also create a domestic market obligation and possibly price controls. While the existing Oil and Gas Law stipulates that such domestic pricing shall be left to market mechanisms, the government with the approval of the House of Representatives will have to authority to regulate oil and natural gas prices that are marketed domestically,  A minimum 25% domestic market obligation is also planned to be applied and sales of state owned oil and gas shall be carried out by the Development Body.

With respect to the extension of cooperation contracts, such extensions may be proposed by the cooperation contract contractors.  However, the new draft oil and gas law will require the approval of the House of Representatives and state owned enterprises shall be given the right of first refusal.

At the moment the draft oil and gas law is being intensively discussed by the Commission VII of the House of Representatives.

This article is part of our 2011 Indonesian Law Review series, in which our attorneys discuss recent legal developments  over the past year and track the main trends in each industry. We’ve also published reviews of Environmental Laws, Mining, Investment and Geothermal Mining & Power Production, and Shipping.