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Tribunal sheds light on Umeme`s tax woes and battles with power regulator

After years of raking in free money through inflated projections of some of its costs, Umeme is finding it difficult to make easy money, with the company in the process of making one last stand against government�s proposals on how electricity tariffs – the power supplier�s main cash cow – should be set.

According to dozens of documents � some of which are labeled �strictly confidential� � the Electricity Regulatory Authority remains dissatisfied with Umeme over how it has made free money, even when the company enjoyed a cool 20 per cent investment return over and above its costs.

That tension has boiled over to the Electricity Disputes Tribunal, where the two institutions have for the last two years contested the manner in which power tariffs should be set. The tribunal resumes tomorrow after a three-week break, and could have the matter resolved before the end of this year.

At the centre of the dispute are two items that ERA says Umeme has exploited to set higher power tariffs for its own financial benefit: the income tax and power purchases. As part of the agreement with government, Umeme is allowed to factor all its costs within the power tariff. The company sets the tariff by making projections of its costs based on what it spent the previous year. It sends that figure to ERA for approval.

However, ERA discovered that Umeme�s submission of the amount it intended to pay in, for example, income tax for a given year, which it factored in the electricity tariff, was usually higher than what it reimbursed government, leaving Ugandans with the burden of paying higher power bills.

The tax numbers are startling. For example, in 2008, Umeme wrote to government and said it expected to pay a tax of Shs 12.1bn that year, which it wanted integrated into the power tariff. Instead, Umeme paid only Shs 2.9bn that year, with the rest of the money going to its coffers. The widest variance, however, came in 2011. In that year, Umeme said it would pay Shs 18.8bn in income tax.

But when URA finally received Umeme�s income tax filings for that year, the company had only paid Shs 3.5bn, while the other Shs 15.3bn had been pocketed. By the time ERA added up the tax numbers from 2005, when Umeme�s 20-year concession started, to 2011, Umeme had made an extra Shs 37.3bn in revenue from setting a higher tax within the power tariff. Umeme disputes these numbers, and says the figure is lower.

To be fair, Umeme cannot be faulted for failing to come up with the exact projection of its costs. However, the margin of error in the figures it presented was usually so wide it pointed to potential abuse by the power firm over the privilege it enjoyed.

On energy purchases, Umeme used almost a similar trick. ERA has found out that over the years, Umeme had purchased more power than it had projected. ERA has recovered up to Shs 32bn ($11.8m) from Umeme�s accounts as a result of an increase in the energy purchase the company had made.

If ERA had not intervened, the authority said Umeme would have placed higher electricity tariffs and made Shs 351bn ($130m) through energy purchases between 2013 and 2018. Ugandans pay one of the highest power tariffs in Sub Saharan Africa. Domestic consumers pay a tariff of Shs 518 per KwH, which is $0.19, far higher than the Sub Saharan Africa average of $0.13.

Uganda produces about 800MW of power today, which is shared by less than 15 per cent of the population, far below the Sub Saharan average of 24 per cent, according to the World Bank. At the tribunal tomorrow, ERA, through its lawyers, Ligomarc Advocates, will push for amendments on Umeme�s license, especially on how the tariff is set and the inclusion of a reconciliation mechanism if there is a difference in the financial figures of the income tax and energy purchases.

The reconciliation mechanism would offer ERA the power to always claw back any revenues that Umeme made outside what it had projected, and probably bring electricity tariffs down. The lawyers are expected to argue that the revenues Umeme is reaping from the income tax and energy purchases are not special benefits for meeting its performance targets.

�The use of projections without providing for reconciliation mechanisms results in an unjustified windfall for [Umeme] whenever the actual outturn exceeds the projection. This creates an additional and unjustified burden with the tariff to the consumer,� Benon Mutambi, the chief executive officer of ERA, wrote in a witness statement, dated March 7, 2014.

Umeme is expected to make strong objections. The company says it is acting within its license requirements. If anything, Umeme warns of dire consequences if ERA continues to dip its hands into this revenue kitty. In its application to modify its licence to ERA, published in February this year, Umeme complained that ERA�s continued pursuit of those extra revenues leaves it with two options: �forgo an equivalent amount of the capital investment, or borrow more money.

The combined impact of these modifications, in increasing Umeme�s costs and reducing its revenues from future addition electricity sales, places a serious strain on Umeme�s ability to raise sufficient debt finance, on commercially reasonable terms.�

Life could turn out tougher for Umeme given that the escrow account, one of the company�s fallback positions remains empty because the Uganda Electricity Distribution Company Limited is too broke to meet its part of the deal of financing that account.

In fact, Mutambi, in September 2013, accused Umeme for illegally tapping into the escrow account after the company argued that it had not recovered all its costs. He said Umeme had been compensated for its costs in the tariff, and therefore it was �erroneous� for the utility firm to withdraw money from the escrow account as that amounted to double recovery.

History

So, how did Umeme find itself with all these benefits? Why did ERA allow all the things it accuses Umeme of to go on for so long?

The answers can be traced back to the first few years of Umeme�s operations in Uganda. Before Umeme came to Uganda, the energy industry had been mired in all sorts of scandals. The Uganda Electricity Board, then the managing body for the sector, was saddled with high debts, poor management, and political interference.

On top of that, UEB was the regulator, the generator, and distributor of power, roles that pointed to a conflict of interest. UEB was also choking from a huge number of redundant staff, so much so that when the body was unbundled into three separate companies in 2001, more than 300 staff were laid off. Power theft was at its most rampant, while a number of government institutions blatantly refused to clear their power bills.

Even the available power, which was exposed to theft, was not enough, with less than 5 per cent of the population getting access to electricity. Matters were not made any easier when AES, the American firm that was awarded the deal to build the country�s biggest power plant, the 250MW Bujagali project, in 2001, pulled out two years later after being implicated in a corruption scandal back home.

The World Bank, which had agreed to finance the plant, also pulled out of the project. With the collapse of the Bujagali project, government was desperate to reduce its role in the energy sector and hand that task to a private investor.

In March 2005, Umeme was handed a 20-year concession to be Uganda�s main power distributor. Umeme had just been created 10 months earlier through a consortium between Eskom Enterprise Limited PTY and Globeleq (Conco) Holdings of Bermuda. Globeleq later bought out Eskom�s stake.

In 2006, Uganda faced its biggest power shortage. A long spell of drought led to a drop in water levels at Lake Victoria, where much of the power generation was taking placing. Power generation dropped by more than a half. A schedule to ration power supply was instituted. Some areas went an entire day without power.

A number of factories that could not stand this madness relocated to other countries where power was available. The power problem almost brought Uganda�s economy to its knees. It is at that point that Umeme threatened government that it would terminate the concession and leave the country if the power shortage, which threatened its revenue streams, continued.

Uganda was in a desperate corner. The country made some concessions to Umeme, which, it now turns out, the company would later use to its advantage.
Special provisions

With its business at risk, Umeme proposed some amendments to its supply license back in 2006. Umeme requested government to give it the freedom to make forecasts on energy purchases, which it would factor in the power tariff.

The deal was simple: if government failed to generate enough power that Umeme needed to supply and make its return on investment, the company would be compensated. However, if power generation improved beyond what Umeme had projected, the consumers would be relieved through lower tariffs. Government agreed to the conditions.

ERA, by that time, was barely five years old. The regulation of the sector was weak. And they were about to get a painful lesson from a company that had just received more than enough freedom to set power tariffs.

Power supply improves

Between 2006 and 2010, Uganda was in a race to save its economy from buckling under the weight of less hydroelectricity. The country invited companies such as Aggreko, Jacobsen and Electromaxx to produce the far more expensive thermal power. The companies demanded for subsidies before they could switch on their generators.

While Uganda was looking for money to deal with its energy problem, the World Bank�s Multilateral Investment Guarantee Agency was channeling millions of dollars to Umeme through Globeleq�s office in Bermuda. Bermuda, an island dripping with all sorts of illicit financial flows, is known to be a tax haven. Companies, some dubious, open up offices there mainly to pay lower tax on their investments.

There is no evidence, however, that pointed to Globeleq engaging in any illicit financial activities while it channeled money to Uganda. In October 2009, Globeleq Holdings changed its names to Umeme Holdings Limited which moved its head office to a nearer tax haven, Mauritius, a country that has a double taxation treaty with Uganda.

Thereafter, the United Kingdom�s Commonwealth Development Corporation, which was the main shareholder in Globeleq, transferred its stake to Actis, a private equity firm, to take over Umeme Holdings Limited. Heavy rains were back in Uganda, which spurred electricity generation, while other smaller hydro power plants had been launched. The 250MW Bujagali power project had just been revived and approved.

The situation had normalised. Things had turned for the better that government, in 2009, set up a five-man committee, led by the president�s brother, General Salim Saleh, to look at Umeme�s investments in Uganda. The team was suspicious of Umeme�s investments and wanted that verified, among other things.

(That report, which had a damning assessment of Umeme, would later be criticised by some government officials, and shelved. Members of Parliament would have the same suspicions over Umeme and have said as much in another disputed 2013 report about the energy sector. )

In 2010, government decided to stop the special provisions that Umeme enjoyed. That decision would lead to a long protracted battle.

Payback time

When government decided to end the special provision period in 2010 in order to reconcile the projections Umeme made, and also change the way the tariff was set, the company decided to block that move. Umeme, according to the documents The Observer has seen, first pointed to the agreements it signed with government.

�Some of those agreements contain provisions which restrict the Authority from amending or modifying the Tariff code regulations in a way that affects the financial position which Umeme enjoyed,� the company wrote to ERA in 2012, and even threatened to terminate its license if the regulator got its way.

Umeme used some numbers to prove its point. The company argued that for every $1m of investment that is not included in the tariff, it would lose $31,000 of revenue each month. For an annual capital programme, it added, this equated to just under $1m per month.

�In simplistic terms, the amendment, as proposed by the Authority would reduce Umeme�s free cash flow by approximately $50m over the next seven years. This would reduce Umeme�s ability to make capital investments and would result in Umeme being in breach of multiple financial covenants under its loan agreement with the IFC (International Finance Corporation, the finance arm of the World Bank).

The company added: �Umeme�s view is that the disadvantages it would suffer based on some of the proposed modifications outweigh the benefits of the public interest.�

ERA would not relent. Instead ERA sought a different way of setting the tariff � pegging the rate to inflation, the exchange rate and fuel prices. Umeme also had reservations about this method. And yet, Umeme�s resistance is not the only problem that the regulator faced.

ERA, it now appears, suspected that Umeme was not just inflating its tax and energy purchase projections; The company was doing the same with its other costs. In 2012, a consulting firm from South Africa, Parsons Brinckerhoff Africa (PTY) Ltd issued a report for ERA that showed how Umeme was very likely to balloon some of its future costs, which it intended to pass on to consumers through the tariff.

For example, according to the report, Umeme said it would spend Shs 57.4bn in staff costs for the year 2015, and yet PB�s opinion is that the figure would be Shs 42.3bn. Umeme also said it would spend Shs 15.1bn in repair and maintenance costs in 2015, and yet PB says the amount will actually be Shs13.9bn. Umeme objected to the report�s findings.

It might not be easy for ERA to pin Umeme on these numbers. The authority has already complained that Umeme was reluctant to send its financial data to the authority whenever a verification exercise took place.

In September 2013, ERA�s boss Mutambi, wrote to Umeme assuring the firm that �The failure/refusal by Umeme Limited to submit monthly statistics which are vital data for use in reconciliations impedes and inhibit the Authority�s mandate to prescribe the end user electricity tariffs.�

Tough times ahead?

If Umeme�s half year results to June 2014 are anything to go by, then perhaps the company could face some tough time ahead. The company recorded a drop in net profit of Shs 38.2bn ($14.1m) in the first six months of 2014 compared to Shs 47.3bn ($17.5m) over the same period last year.

Yet, these numbers have done very little to dampen the mood on the Umeme counter at the Uganda Securities Exchange. This point was made clear in the first two weeks of this month when investors dashed for the company�s share, driving the price to a new high. Deals worth billions of shillings were being inked in a day, something that is rare at the securities exchange.

For example, on the second day of October, an investor bought four million Umeme shares at a deal worth Shs 2bn (about $740,000). Five days later, an even bigger stake was bought. An investor cashed in Shs 21bn (just more than $8 million) and walked away with slightly more than 42 million shares of Umeme.

And less than a week later, a block of 14 million Umeme shares changed hands in a deal worth Shs 7.17bn ($2.6 million). These deals saw Umeme�s share price shoot to a new high of Shs 510, up from its Initial Public Offer price of Shs 275 two years ago.

A top chief executive officer of a brokerage firm said it was likely that investors were targeting the stock in anticipation of the half year dividend of Shs 9.4 that the company will be issuing a few days before Christmas. What the investors might not know is that ERA has also written to Umeme over the manner in which Umeme Holdings divested its stake, which led to a new company, Investec, to become a majority shareholder.

ERA says that by Umeme Holdings relinquishing its majority stake, it has violated the terms of its licence since the company might not be able to make critical decisions about the sector. That battle over Umeme and ERA is quietly picking up storm, with meetings taking placing between the two institutions.

For now, the attention is on the power tariff, the power supplier�s cash cow, where ERA intends to bite a sizeable pound of Umeme�s flesh.

This story first ran in The Observer. Jeff Mbanga is a partner at Deep Earth International.

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