Kampala — Hardman Petroleum Resources did not follow the Oil Production Sharing Agreement (PSA) to the letter for Block 2 in the Albertine graben, auditors have discovered.

Ernst & Young, an audit firm, also discovered that Hardman, that was eventually taken over by Tullow, breached local tax laws and made Ugandan taxpayers bear customs and excise duty on imports not related to petroleum operations.

The company also disregarded local regulations in their financial statements and imported locally available materials in disregard of the PSA.

"There could be need to justify why some items that were locally available in Uganda and whose price and quality is satisfactory were imported yet the PSA indicates that preference should be given to goods locally available in Uganda," the auditors said.

They recommended that the Government should regularly review all import schedules of the oil exploration companies to confirm that the imports are in line with PSA before any tax payments.

The audit, commissioned by the Auditor General, covered the period October 2001 - October 2006 before Tullow took over Bock 2 exploration works. It was meant to verify whether the recoverable expenses claimed by Hardman occurred in reality and were accurate and in line with PSA.

Oil companies recover their exploration costs first when commercial exploitation begins.

During the review, the auditors said they unearthed 20 cases regarding non-compliance with the oil exploration and development regulatory framework, lack of internal controls, non- compliance with the Ugandan tax laws as well as breach of the procurement and environmental regulations.

"We have identified instances of noncompliance with the production sharing agreements, Petroleum Exploration Act and the international petroleum industry practices and standards," the auditors said in the 74-page report.

When contacted, energy ministry permanent secretary, Kabagambe Kaliisa, confirmed receiving the report.

However, while the final report was handed over to the ministry in April last year, Kaliisa said there were other facts that still needed to be incorporated to make the report complete. He declined to disclose the missing facts.

But the auditors challenged the $39,262,492 (sh82b) figure which the oil company stated as recoverable expenditure.

"Based on the agreed upon procedures that we performed, we found that expenditure amounting to $39,205,909 is eligible as recoverable expenditure," the auditors said. This leaves a difference of $56,583, which should go to the Government coffers. It was discovered that Tullow listed its image-building community projects like classrooms construction, as part of the recoverable costs, which was disputed by the energy ministry.

Following the discovery, the company then agreed to strike the cost off the recoverable list.

The auditors also discovered that the oil company did not file its tax returns on time and that it had accumulated withholding tax liabilities totalling $2.85m (sh6.3b) with a potential penalty of up to $1.22m (sh2.7b). But the company has disputed the figure saying it was based on wrong computation.

"Management does not agree with the auditors' estimate of potential withholding tax liability on the basis that the assumptions under which it was calculated are incorrect and therefore, the liability calculated is misleading," reads their response.

The auditors also raised concerns over absence of a frequent internal audit function in the oil company, leading to potential danger for fraud and error going unnoticed. They also said local accounting regulations were disregarded by the company in its financial reports.

"Our review of the audited financial statements revealed that there was no consideration of the local regulatory framework like the Petroleum (Exploration and Production) Act Cap 150, the PSA, the National Environment Management Authority and other local laws and regulations," the report said.

The company insisted that their accounting records complied with PSA requirements and recognised accounting systems.

The other findings were that Ugandans risked paying highly since the oil company did not use the recommended competitive procurement process and entrusted a lot of services to BMS Mineral Ltd, a company where the then country manager, John Morley, was a shareholder.

"We note the contracting of a number of services like human resource, construction and logistics services to BMS Minerals Limited, a company owned by the then country manager of Tullow Uganda yet there were a number of complaints from the Government about the substandard work done by the company especially on road construction," the report said.

"Failure to apply the procurement procedure while acquiring goods and services may lead to the licensee being provided with low quality services for high prices which are then transferred to the government as recoverable costs," observed the report.