Disclosing government paymentsImplications for the oil and gas industry

Disclosure requirements for payments to governments for natural resource extraction industriesIt is estimated that more than 3.5 billion people live in countries with extensive oil, natural gas and mineral resources. With good governance that fosters sustainable development free from corruption, these natural resources can add greatly to the quality of life for the people of such countries. Proper development can foster broad economic growth beyond the natural resources and go a long way to reducing or eliminating poverty and the social problems that it creates. Further, there is a broad view that greater transparency in the natural resource extractive industries will support proper development. Essentially, companies disclose that which they pay to governments to verify that which governments say they receive from companies.

Consequently, three major efforts have emerged to require disclosure of government payments. The first was the Extractive Industries Transparency Initiative (EITI), which is a set of reporting standards published by a coalition of companies, governments and non-governmental organizations (NGOs). EITI was followed by legislation enacted in the United States under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which requires certain disclosures by natural resource extractive companies that are subject to the reporting requirements of the US Securities and Exchange Commission (SEC). Finally, the European Union (EU) recently approved a rule requiring the disclosure of payments made to governments by both listed and large, non-listed natural resource extractive companies.

The following is a brief summary of the three initiatives, along with a high-level, side-by-side comparison of the reporting requirements from each set of rules.

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Extractive Industries Transparency InitiativeThe EITI was started in 2002 with the goal of enhancing good governance of natural resource development through improving transparency and accountability in the extractive industries. The EITI Association is an organization of sponsoring countries, natural resource extractive companies, other non-governmental organizations (NGOs) representing civil societies and partner organizations that have come together to develop a framework for the disclosure of payments to governments based on two primary elements:

• Companies will publish (disclose) that which they pay to governments, and governments will publish that which they receive from companies in an EITI report.

• The disclosure process is overseen by a multi-stakeholder group of governments, companies and civil society.

Adoption of the EITI standard is discretionary, and implementation is the responsibility of individual countries. In order for a country to become EITI compliant, the government must issue an unequivocal public statement of its intention to implement the EITI and then meet a series of sign-up requirements that demonstrate its commitment to implement the EITI process in the candidate country. Over the next two and a half years, the country must complete the EITI validation process, which includes reporting and governance requirements that are reviewed and confirmed by an independent validator appointed by the EITI.

In effect, the EITI framework and disclosure requirements must be adopted into individual country law, therefore impacting extractive industry companies that operate within the country. The framework also requires the payment reports to be based on accounts that have been audited to international standards. The laws or regulations and the independent auditing process are independently validated by the EITI before the country is deemed to be EITI compliant, and countries must maintain adherence to all the EITI rules in order to retain their compliant status. Presently, the EITI has designated 23 countries as compliant and another 16 countries as “candidates” that are in the process of implementing the EITI rules.

In May 2013 the EITI approved a revised standard that broadens the scope of the reporting obligations for EITI reporters. Going forward, in addition to disclosing revenue information, EITI reporters will also need to disclose information about production volumes, the names of companies holding licenses, and additional information about state-owned oil and gas companies. Additionally, the EITI rules will now require disclosure of payment information by project, aligning it to the Dodd-Frank and EU rules.

The following pages are a side-by-side comparison of the three reporting requirements or regimes. The EITI information is limited to the government payment disclosure requirements for purposes of comparison to EU rules and Dodd-Frank as originally proposed.

Dodd-Frank Wall Street Reform and Consumer Protection ActUnder Section 1504 of the Dodd-Frank Act, Congress added Section 13(q) to the Securities Exchange Act of 1934, which mandates the SEC to issue a rule requiring issuers engaged in the commercial development of oil, gas or minerals to annually disclose the amount of payments by type, by project and by government. Congress enacted the rule to increase the transparency of payments made to governments for the purpose of the commercial development of their natural resources.

In August 2012, the SEC issued its final rule to comply with Section 1504 of the Dodd-Frank Act, requiring all companies subject to SEC rules engaged in the commercial development of oil, natural gas or minerals to annually disclose payments to federal and foreign governments. Under the rule, companies would disclose the type and amount of payments by project and by government for all payments that equal or exceed $100,000 individually or in aggregate. There were no exemptions provided where disclosure of such information was prohibited by a specific country or government. The SEC rule drew significant criticism, including a federal lawsuit filed by a coalition of industry groups alleging the rule was unlawful, and that the SEC had misinterpreted its congressional mandate. A federal court agreed with a number of these allegations, and in July 2013, vacated and remanded the SEC rule for further consideration. It is now up to the SEC to decide whether it will appeal or accept the federal court’s ruling and address those areas of chief concern to the court.

While this puts implementation on hold, the question is not whether there will ever be an SEC rule; rather, the question is what changes, if any, will be made to the existing version. Through Section 1504, the US Congress mandated the SEC to establish such a rule and therefore it is clear that some version of the rule will be re-issued and ultimately, implemented.

European Union Amendments to DirectivesIn October 2011, the European Commission issued two proposals to amend the EU’s Transparency and Accounting Directives (the Directives), which, in part, included a requirement to disclose payments to governments by certain large undertakings and public interest entities engaged in natural resource extraction or logging. Following a series of recent tripartite discussions amongst the Commission, Council and Parliament, a final rule was approved in June 2013. While several elements of the EU rule are similar to the initial Dodd-Frank requirements, there are some important differences, including the scope of companies to which the reporting rules apply.

Further, there are no indications that Europe intends to modify or pull back on implementation of its payment to governments rule based on developments in the US. It is now up to each member state of the EU to adopt the provisions into law no later than July 2015.

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Dodd-Frank Act Section 1504 SEC Rule 13(q)

Amendments to EU Directives

Extractive Industries Transparency Initiative (EITI)

To which industries do the rules apply?

Disclosure of payments to governments is required for “resource extraction issuers.” A resource extraction issuer is any issuer engaged in the “commercial development of oil, natural gas or minerals.”

Disclosure is required of large undertakings and public interest entities active in the extractive industry, or the logging of primary forests.

The EU Commission will consider whether to extend the reporting requirements to additional industry sectors as part of a broader post-implementation review that will occur no later than three years after adoption by Member States.

EITI reporting must apply to all extractive industry companies.

Which entities or undertakings are required to comply with the disclosure requirement?

The rule applies broadly to all US and foreign private issuers (including those that are government owned), regardless of their size or the scope of their activities that are resource extraction issues. The rule does not apply to foreign private issuers that are exempt from Exchange Act reporting obligations and publish their home country annual reports under Exchange Act Rule 12g3-2(b).

Large undertakings and public interest entities active in applicable industries. Large undertakings are defined as undertakings that exceed two of the three following criteria: (1) balance sheet total assets exceed €20 million, (2) net turnover of €40 million or (3) average number of 250 employees for the year. Public interest entities includes listed companies and is defined as entities governed under the laws of a Member States with securities traded on a regulated exchange of any Member States, certain credit institutions and certain insurance entities.

All extractive industry companies (including international, national and state-owned companies) operating in that country.

Are there any exemptions available (e.g., small issuers)?

There are no exemptions. Small and medium-sized undertakings are exempt from the reporting requirement.

An entity may be exempted from reporting only if it can show with a high degree of certainty that the amounts it reports would be immaterial.

Are there any exemptions available if an issuer files under another extractive transparency reporting initiatives?

There are no exemptions. Where equivalent reporting is already required by non-EU countries, companies will be exempt from the EU reporting requirements, other than the obligation to publish the report to comply with EU regulations.

The European Commission will assess third-country reporting requirements to determine whether they are deemed as “equivalent” for purposes of this rule.

This may be addressed in each enacting country’s provisions.

Are there any exemptions available to certain payments when they are prohibited to be disclosed under a government or some other requirement?

No. This lack of exemption was one of the federal courts primary concerns with the initial SEC rule. The court, acknowledging that such a requirement created a significant burden on competition and investors, stated in its decision that a more detailed analysis was warranted in this area.

No. Although considered in drafts of the legislation, the final rule provides no such exemptions.

There do not appear to be exemptions for these types of payments; however, each enacting country may have established different criteria.

The following pages are a side-by-side comparison of the three reporting requirements or frameworks.

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Dodd-Frank Act Section 1504 SEC Rule 13(q)

Amendments to EU Directives

Extractive Industries Transparency Initiative (EITI)

Is the reporting mandatory? Mandatory Mandatory Mandatory, if adopted by country

Is an audit of the annual report required?

No No, though the rule calls for a post-implementation review, which would consider whether the report should be audited in the future.

Yes

How are the industries defined?

Activities subject to disclosure include exploration, extraction, processing, export and other significant actions relating to oil, natural gas or minerals, or the acquisition of a license for any such activity. The rule does not include marketing, transportation, refining or smelting activities. Logging activities are not included.

Defined as companies with any activity involving the exploration, prospection, discovery, development, and extraction of minerals, oil, natural gas deposits or other materials.

Logging activities include clear cutting, selective logging and thinning on land containing primary forest areas. Also included is the disturbance of primary forests by mining, mineral, water, oil or gas extraction activities. Support services to the extractive and logging industries are not included in the disclosure requirement.

While extractive industries are referenced generally, the EITI criteria repeatedly refer to oil, gas and mining. Each enacting jurisdiction may have expanded the scope to include logging and other extractive industries not specifically mentioned.

Which payments must be disclosed?

The rule requires disclosure of all payments (including in-kind payments) that are “not de minimis,” including the following:

• Taxes that are based upon corporate income, production and profits (payments for taxes levied on consumption, such as value-added taxes, personal income taxes or sales taxes, are not required to be disclosed)

• Royalties

• Fees (including licensing fees)

• Production entitlements

• Bonuses

• Dividends (these need not be disclosed if paid as common or ordinary shareholders and under the same terms as other shareholders unless the dividend is paid in lieu of production entitlements or royalties)

• Infrastructure improvements such as building a road or railway (not including social payments such as costs to build schools)

Payments are defined as amounts paid, whether in money or in kind, of the following types:

• Production entitlements

• Taxes levied on the income, production or profits of companies, (excluding taxes levied on consumption such as value-added taxes, personal income taxes or sales taxes)

• Royalties

• Dividends

• Signature, discovery and production bonuses

• License fees, rental fees, entry fees, and other considerations for licenses and/or concessions

• Payments for infrastructure improvements

The following revenue streams should be included in the payments to be reported:

• Host government’s production entitlement

• National state-owned company production entitlement

• Profit taxes

• Royalties

• Dividends

• Bonuses (such as signature, discovery and production)

• License fees, rental fees, entry fees and other considerations for licenses and/or concessions, and other significant benefits to the government as agreed upon by the multi-stakeholder group

How do the rules apply to consolidated groups?

Any payments made by the issuer, a subsidiary of the issuer or another entity it controls (based upon facts and circumstances as defined under Rule 12b-2). The SEC defines control as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise.

If the parent undertaking is required to prepare consolidated financial statements, it must also prepare the report of payments to governments on a consolidated basis, reporting the activity of any of its subsidiary undertakings that are active in the extractive industry. When a consolidated report is prepared, the subsidiaries are not required to report separately.

Those companies operating in the jurisdictions that have adopted EITI are required to report their payments to the federal and local governments.

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Dodd-Frank Act Section 1504 SEC Rule 13(q)

Amendments to EU Directives

Extractive Industries Transparency Initiative (EITI)

How are in-kind payments valued?

Issuer may report in-kind payments at cost or, if cost is not determinable, at fair market value and must include a brief description of how the value was determined.

Payments in kind are to be reported based on their value and, “where applicable,” volume. Where reported in value, there are to be notes describing how such value was determined.

When agreements based on in-kind payments, infrastructure provision or other barter-type arrangements play a significant role in the oil, gas or mining sectors, the multi-stakeholder group is required to agree to a mechanism for incorporating benefit streams under the agreements into its EITI reporting process.

To which government bodies do payment disclosure rules apply?

The rule does not apply to any US governmental entities other than the federal government. The definition of “foreign government” includes a department, agency or instrumentality of a foreign government or a company owned by a foreign government. This would include the government of a state, province, county, district, municipality or territory under a foreign government.

“Government” includes any national, regional or local authority of an EU Member States or of a third country. This includes a department, agency or undertaking controlled by that authority.

“Control” is defined in the same manner that is used for determining members included in a consolidated financial statement.

Payments made to the national government, as well as payments to local governments, must be reported. Payments that may be immaterial for the national government may be material to the local government and must be reported.

Is there a materiality or de minimis threshold below which payment disclosure is required?

Any payment (single or series of related payments) that equals or exceeds $100,000 during the respective fiscal year will be required to be disclosed.

Any payment, whether made as a single payment or a series of related payments, need not be disclosed if it does not exceed €100,000 within a financial year.

The rule states that payments disclosed should reflect the substance, rather than the form, of the payment or activity concerned. Payments and activities may not be artificially split or aggregated to avoid the disclosure requirements.

Companies are only required to report material payments. Materiality is determined ahead of time as the criteria are being developed among members of the multi-stakeholder group.

Should payments be reported on a cash or accrual basis?

Payments are required to be disclosed on a cash basis.

Cash or accrual basis is not specified in the Directives.

The EITI criteria does not specify cash or accrual; however, the amounts reported are verified pursuant to an audit of the payments under international auditing standards.

What currency should the companies use for the disclosures?

In either US dollars or the issuer’s reporting currency. Translation if applicable can occur in one of three ways: (1) by translating at the exchange rate existing at time of payment, (2) using the weighted average of the exchange rate during the period or (3) based upon the exchange rate as of the issuer’s fiscal year-end. The issuer must disclose the method used to calculate the currency conversion.

Member States that have not adopted the euro should apply an equivalent reporting threshold by translating €100,000 into the national currency. Although not specific in the Directives, we believe entities would be required to disclose payments in their reporting currency.

Currency is not addressed.

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Dodd-Frank Act Section 1504 SEC Rule 13(q)

Amendments to EU Directives

Extractive Industries Transparency Initiative (EITI)

Do the rules provide any relief for situations where obtaining data for disclosure is overly burdensome?

No relief is provided. Where entities prepare a consolidated report on payments to governments, a consolidating entity need not include subsidiary undertakings in its report where one or more of the following conditions exists:

• Severe long-term restrictions hinder the parent undertaking in the exercise of its rights over the assets or management of a subsidiary undertaking.

• Extremely rare circumstances where the information necessary for the preparation of the consolidated report cannot be obtained without disproportionate expense or undue delay.

• The shares of that undertaking are held exclusively with a view to their subsequent resale.

The above exemptions only apply if they are also used for the purposes of the consolidated financial statements.

No relief is provided; however, enacting jurisdictions may provide for relief under their provisions.

How should the payments be reported?

The original rule required disclosures to be presented on a new Form SD, which should include a brief statement in the body of the form entitled “Disclosures of Payments by Resource Extraction Issuers” directing users to the exhibit detailing payment information, which is subject to Exchange Act Section 18 liability. The form will not require officer certifications.

Reporting will depend on implementation by each Member State.

Companies file their information pursuant to the agreed-upon reporting templates.

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Dodd-Frank Act Section 1504 SEC Rule 13(q)

Amendments to EU Directives

Extractive Industries Transparency Initiative (EITI)

Which kind of detail of each payment needs to be made available in the disclosure?

Each payment will be disclosed and listed in the attached Exhibit to Form SD as follows:

• By type and total amount of payments made for each “project”

• By type and total amount of payments made to each government

• Total amount of the payments, by category

• Currency used to make the payments

• Financial period in which the payments were made

• Business segment that made the payments

• The government that received the payments, and the country in which the government is located

• The project of the issuer to which the payments relate

The report is required to include the following in relation to the relevant financial year:

• The total amount of payments made to each government

• The total amount per type of payment (see above for applicable payment types) made to each government

• Where payments have been attributed to a specific project, the total amount per type made for each project and the total amount of payments for each project

The EITI update, issued in May 2012, requires payments to be reported for each “project,” aligning the requirement to Dodd-Frank and the EU rule. The specific form of reporting is pursuant to the agreed-upon reporting templates for each country.

What about entity-level payments versus project-level payments; do they need to be apportioned to the project?

Certain payments (such as corporate taxes) may be disclosed at the entity level rather than apportioned to the project level.

Payments made by the company for obligations levied at the entity level can be disclosed at the entity level rather than at a project level.

The amended EITI standard requires that payments are disclosed at the individual entity level and at the project level, where applicable.

Is the term “project” defined? The SEC did not define the term “project”; however, the rule requires disclosure at both the project and country levels. The SEC noted that issuers typically present information on a project basis in their Exchange Act filings. The SEC indicated that this is the level of project disclosure that it expects.

Additionally, the phrase “business segment” should be defined consistently with the reportable segments used by the issuer for financial reporting purposes.

“Project” is defined as “operational activities governed by a single contract, license, lease, concession or similar legal agreements and form the basis for payment liabilities with a government. Nonetheless, if multiple such agreements are substantially interconnected, this shall be considered a project.”

The amended EITI standard mandates reporting at the project level, provided it is consistent with the US and EU standards. Beyond that, there is no specific definition of “project” in the standard, effectively leaving it to individual country multi-stakeholder groups to mandate the level of disaggregation required in the report.

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Dodd-Frank Act Section 1504 SEC Rule 13(q)

Amendments to EU Directives

Extractive Industries Transparency Initiative (EITI)

What is the effective date for these rules?

The rule was to become effective for fiscal years ending after 30 September 2013, with reporting required for payments made after 1 October 2013. However, the recent federal court decision means there is significant uncertainty as to when a revised rule will be issued and become effective.

Each Member State is responsible for implementing the rule within two years in its own jurisdiction.

The EITI provisions are enacted within each country that is a candidate for becoming EITI compliant. The actual date of enactment will vary by country.

What is the regular reporting deadline?

Form SD will be required to be filed no later than 150 days after a company’s fiscal year-end, though the timing of implementation is now uncertain as a result of the ruling.

Reporting will depend on implementation by each Member States.

Implementing countries are required to produce their first EITI Report within 18 months of being admitted as an EITI Candidate. Thereafter, implementing countries are expected to produce EITI Reports on an annual basis.

What is the electronic format of filing (PDF, etc.)?

The exhibit will be required to be formatted in an interactive format with Extensible Business Reporting Language (XBRL) tags.

This is not addressed in the Directives. This is not addressed.

Must wholly-owned subsidiaries file separate reports if the parent has filed a consolidated report on payments to governments?

Such subsidiary shall not be required to separately file but would file a notice on Form SD providing an explanatory note that the required disclosure was filed by its parent and the date the parent filed the disclosure. In addition, the parent must note its filing of the disclosure on behalf of its subsidiary.

The obligation to report government payments separately does not apply to a subsidiary or parent undertaking that is governed by the laws of a Member States and whose government payments are included in a consolidated report filed by the parent undertaking.

Those companies operating in a jurisdiction that has enacted the EITI provisions are required to file.

Are there penalties for failing to comply with the relevant disclosure or reporting requirement?

While not explicitly stated in the Rule, the SEC could suspend and/or revoke a company’s registration under Section 13 of the Exchange Act due to failure to make the required periodic filings.

The amended Directives provides that the Member States are to provide rules for penalties for instances of non-compliance with the Directives.

The EITI criteria do not specifically address penalties; however, the enacting jurisdictions address this.

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ChallengesAs can be seen, these disclosure standards all vary, so it will be a challenge for affected companies to ensure compliance since they may be subject to multiple standards. Every country looking to become EITI compliant will establish disclosure and reporting standards that may differ from those adopted by the European Union and the initial SEC Dodd Frank rule.

The recent federal court ruling has created uncertainty as to the final form and timing of the US rule. If dramatic changes are made, there is a risk that the European Union could view the US rule as not being “equivalent”, therefore subjecting certain companies, such as SEC foreign filers, to reporting under both regimes. In addition, both the final EU rule and the current SEC rule contain provisions that will need to be carefully evaluated by companies. Neither rule provides an exemption from disclosure in instances where disclosure may be prohibited by a country or a confidentiality clause in a contract. Companies subject to these rules will need to evaluate the laws in the countries where they operate, along with confidentiality agreements in their contracts. If these arrangements prohibit disclosure, those companies will have to consider future actions (e.g., obtain a waiver from the country, determine whether to continue operations).

Companies will also need to determine how to disclose payments made under any joint operating arrangements. The disclosure requirements for these arrangements are not clear because the SEC did not provide guidance on proportional reporting of payments made under joint operating agreements. The European rule is equally unclear as to whether the rules will apply to joint ventures, though multiple stakeholders in the legislative process have indicated their intent for such payments to be included. In addition, companies will need to evaluate foreign entities to determine whether the entity could be considered a foreign government under the applicable definition, which includes companies that are majority owned by a foreign government (e.g., a utility may be considered a foreign government).

There will need to be some judgment exercised in determining appropriate “project level” disclosure. We believe that the US SEC will look to other disclosures (e.g., those made in other public documents) to evaluate the company’s determination of a “project.” Similarly, entities will need to consider whether suppliers, contractors and other third parties with whom they do business meet the definition of a government entity for which disclosure of payments is required.

All companies will want to identify the level of disclosure and reporting that will satisfy all standards to which they may be subject. That will mean identifying the appropriate level of granularity required among the disclosure requirements and establishing processes to gather the payment data and assembling for proper reporting. For example, identifying differences between cash basis and accrual reporting will also need to be considered and the related processes to compile the right information for the reporting standard.

While there is now uncertainty on the timing of the US rule, we believe companies should continue their preparation efforts for reporting this information. The SEC still has a mandate from Congress to implement a rule. Globally, there is significant momentum to provide greater transparency around payments made to governments. Putting readiness efforts on hold will mean companies lose momentum, which may prove costly in the long run.

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How EY can helpEY has been at the forefront of research and analysis associated with a wide range of issues underlying resource nationalism and its impact on natural resource development.

EY can help companies with:• Our multidisciplinary network: our network includes dedicated

forensic, assurance and tax policy professionals who assist energy clients from across industries and in countries around the world. As needed, our teams access the deep knowledge and resources of EY, tapping into professionals with core competencies in information technology, environmental health and safety (EHS), internal audit, supply chain risk management, sustainability reporting and a range of other key areas.

• Our data management: at EY, our forensic data analytics approach can be utilized to capture, track and report on payments as required under Section 1504 and the EU rules. Our methodology groups related data and builds models of relationships among and between people, documents and events, giving clear visibility into high volumes of disparate data through visual analytics and customized reporting dashboards. Our forensic data analytics leverage proprietary EY technology, which is supported by subject matter resources in both model-based data mining and in the different global payments required by these disclosure rules. The data captured by using these forensic data analytics can be used to complete the Form SD exhibit detailing payment information in XBRL tags.

• Our global reach: EY’s global highly integrated organization, bringing together more than 167,000 people across 152 countries. With competencies in assurance, tax, advisory and transactions, our professionals are ready to address your needs regardless of your geography or the complexity of your operations.

Disclosing government payments | 9

About EY’s Global Oil & Gas CenterThe oil and gas industry is constantly changing. Increasingly uncertain energy policies, geopolitical complexities, cost management and climate change all present significant challenges. EY’s Global Oil & Gas Center supports a global practice of over 9,600 oil and gas professionals with extensive experience in providing assurance, tax, transaction and advisory services across the upstream, midstream, downstream and oil field service subsectors. The Center works to anticipate market trends, execute the mobility of our global resources and articulate points of view on relevant key industry issues. With our deep industry focus, we can help your organization drive down costs and compete more effectively to achieve its potential.

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