Oil Search/InterOil -- summary under Canadian Buyco

Overview

Oil Search, a Papua New Guinea (“PNG”) corporation listed on the ASX, is proposing to use a newly-incorporated Yukon subsidiary (“Purchaser”) to acquire (under a Yukon Plan of Arrangement) InterOil, which is a Yukon corporation listed on the NYSE but essentially all of whose assets are natural gas assets held in a PNG subsidiary. The consideration incudes not only Oil Search shares or cash (subject to a U.S.$770M cap) but also “contingent value rights,” which will trade on the ASX and will entitle the holder to a cash payment based on the extent to which an interim resource assessment of a PNG natural gas project of InterOil shows a resource of greater than 6.2 trillion cubic feet equivalent ("tcfe"). For example, if the resource is measured at 10 tcfe, the CVRs would pay U.S.$1.17 billion in total. The Arrangement values the equity of InterOil at approximately U.S.$2.1 billion or $40.25 per Common Share. Following the Arrangement, InterOil shareholders will own between 14% and 21% of Oil Search (depending on how many elect for cash). The Canadian tax disclosure suggests that although the CVRs are legally described as “notes,” they might not be subject to the prescribed debt obligation rules given that the amount payable is “uncertain and unlimited.” The U.S. tax disclosure indicates uncertainty as to whether the holders can get the benefit of their basis in the CVRs, and indicates that Code s. 483 imputed interest rules likely would apply.

Oil Search

A Papua New Guinea (PNG) oil and natural gas exploration and production company whose Shares are listed on the Australian Stock Exchange (“ASX”) and the Port Moresby stock exchange. Its American Depositary Shares (currently representing 10 Oil Search Shares) trade on the U.S. over-the-counter market. Its subsidiaries, other than Purchaser, are exclusively non-resident (in PNG, the British Virgin Islands, the Cayman Islands and Australia).

InterOil

A Yukon corporation whose Common Shares are listed on the NYSE and Port Moresby stock exchange and whose sole focus is on Papua New Guinea. Its assets include one of Asia's largest undeveloped gas fields (the Elk and Antelope Fields) in the Gulf Province in PNG, and exploration licenses covering about 16,000 sq. km. Its subsidiaries are exclusively non-resident (in PNG, the Bahamas, Barbados, Singapore and Australia).

Purchaser

A newly-formed Yukon corporation which is wholly owned by InterOil.

“Consideration” (for InterOil Shares/RSUs)

Consists, at the choice of the InterOil Shareholders and RSU Holders, of either: (i) 8.05 Oil Search Shares (or, at the election of a Shareholder, the number of Oil Search ADSs representing 8.05 Oil Search Shares); or (ii) a cash amount equal to the product of 8.05 and the 5-day volume weighted average price of Oil Search's shares on the ASX calculated as of the third business day prior to closing, provided that the aggregate cash consideration will not exceed U.S.$770M (with proration applying where this is relevant). In addition, each Shareholder and RSU Holder will also receive, in exchange for each Common Share (including each Common Share issued to holders of RSUs pursuant to the Arrangement), a CVR which will represent the right to receive a contingent payment in accordance with the terms and conditions of the CVR Agreement.

Contingent Value Rights (CVRs)

Each CVR (governed by a “Note Trust Deed” beteeen Oil Search and an Australian Note Trustee) will deliver a contingent cash payment (the “Redemption Amount”) of approximately US$6.044 for each trillion cubic feet equivalent ("tcfe") of the volume of the Elk Field and Antelope Fields in Papua New Guinea that is above 6.2 tcfe. Any amounts payable on the CVRs will be paid in cash upon completion of an interim Resource certification process. The CVR provides Shareholders and RSU Holders, through their entitlement to hold CVRs, with an uncapped potential additional payment, depending on the volume of such Resources. The CVRs are expected to be listed on the ASX. Sample calculations of the amounts payable for different levels of Resources are:

Plan of Arrangement

1. The InterOil Shareholder Rights Plan will be terminated.
2. InterOil Dissent Shares will be transferred to Purchaser.
3. Unexercised options on InterOil shares will be cancelled.
4. InterOil RSUs will be deemed to vest.
5. In consideration for the Consideration issued or paid by Oil Search (for the benefit of Purchaser in 6) to InterOil’s shareholders, Purchaser shall issue common shares to Oil Search with an aggregate fair market value (“FMV”) and stated capital equal to the FMV of the Consideration.
6. Purchaser will purchase all of the outstanding Company shares for the Consideration paid by Oil Search (5 and 6 occur simultaneosly).

Ineligible Foreign Shareholders

Will not receive Oil Search Securities or CVRs. Instead, the Oil Search Securities and CVRs will be issued to the Depositary for sale on their behalf. "Ineligible Foreign Shareholder" means a Shareholder or RSU Holder who Oil Search reasonably believes it would be contrary to applicable law to issue Oil Search Securities or CVRs to. Those with addresses, as shown in the Common Share and RSU register as at the Effective Date, is a place inside the U.S., Canada, Singapore, Bahamas, PNG, the United Kingdom, Australia, New Zealand, the British Virgin Islands, Hong Kong, Malaysia, or the Philippines is not an Ineligible Foreign Shareholder, unless Oil Search reasonably believes that it would be unlawful to issue Oil Search Securities or CVRs to them.

Canadian tax consequences.

Exchange

A Canadian Holder will realize a capital gain (or capital loss) on disposing of InterOil Common Shares under the Arrangement.

Receipt of CVRs

The characterization of the CVRs is unclear. The CVRs should be considered to be additional proceeds received on the disposition of Common Shares in an amount equal to the fair market value of the CVRs at the time of the disposition. The cost to a Canadian Holder of the CVRs should generally be equal to the FMV of the consideration for which the CVRs were exchanged at the time of the exchange.

Accrual on CVRs

The CVRs are legally described as notes and constitute unsecured obligations of Oil Search. If the CVRs are considered to be a debt obligation for the purposes of the ITA (notwithstanding that the amount ultimately payable under the CVRs is uncertain and unlimited), a Canadian Holder may be required to accrue as income the maximum amount payable under the CVRs held by them (generally in excess of the amount for which the CVRs were issued), in the taxation year of the receipt of the CVRs, in the period during which the CVRs are held, or on a disposition of the CVRs (including in connection with the receipt of a Redemption Amount).

Disposition of CVRs

In general, a Canadian Holder that receives a payment of the Redemption Amount pursuant to the terms of the CVR Agreement or otherwise disposes of a CVR will realize income (or loss) or a gain (or loss), to the extent that their proceeds exceed (or are less than) the cost of the CVR to the Canadian Holder immediately before the time of disposition. The character of any such amount as being ordinary income (or loss) or a capital gain (or capital loss) is uncertain. The amount of income or gain realized by a Canadian Holder on a disposition of a CVR should reflect any amount previously included in income by the Canadian Holder in respect of the CVR.

U.S. tax consequences

Exchange

The receipt of the Consideration in exchange for Common Shares will be a taxable transaction for Code purposes.

PFIC rules

Oil Search has not made a determination of whether it is or ever has been a PFIC.

CVRs

The amount, timing and character of any gain, income or loss with respect to the CVRs are uncertain. For example, it is possible that payment of any Redemption Payment, up to the amount of the U.S. holder's adjusted tax basis in the CVR, may be treated as a non-taxable return of a U.S. holder's adjusted tax basis in the CVR, with any amount received in excess of such basis treated as gain from the disposition of the CVR, or possibly another method of basis recovery may apply. Further, it is not clear whether any Redemption Payment may be treated as a payment with respect to a sale or exchange of a capital asset or as giving rise to ordinary income. A U.S. holder who does not sell, exchange or otherwise dispose of a CVR may not be able to recognize a loss with respect to the CVR until such holder receives a Redemption Payment or the right to receive such payment terminates.

Imputed interest

Although not entirely clear, any Redemption Payment received more than six months following the consummation of the Arrangement, may constitute imputed interest taxable as ordinary income under s. 483. The portion of any Redemption Payment treated as imputed interest under s. 483 generally should equal the excess of the amount of the Redemption Payment over the present value of such amount as of the consummation of the Arrangement, calculated using the applicable federal rate as the discount rate. A U.S. holder of a CVR must include in its taxable income interest imputed pursuant to s. 483 using such U.S. holder's regular method of accounting.

Disposition of CVRs

Upon a sale or other disposition of a CVR, a U.S. holder generally should recognize capital gain or loss equal to the difference between (1) the sum of the amount of any cash and the fair market value of any property received upon such sale or exchange (less any imputed interest, as described below) and (2) the U.S. holder's adjusted tax basis in the CVR.

Australian tax consequences.

Exchange

As a general rule, a capital gain or capital loss will be realized upon the disposal. The capital proceeds received by an Australian Participant will be equal to the cash received or the market value of the Oil Search Shares received on the Effective Date plus the market value of the CVR on the Effective Date. Australian Taxation Office guidance indicates that the VWAP of the Oil Search Shares and CVR on the Effective Date should be used as the method to determine their market value.

Rollover treatment

Broadly, scrip for scrip roll-over relief may be available to defer a capital gain made by a taxpayer, if under an arrangement, a taxpayer exchanges a share in a company for a share in another company and certain conditions are met. This is only applicable to the extent that the Participant elects share rather than cash Consideration, and does not cover any gain attributable to the value of the CVR.

PNG tax consequences

Gains arising from the disposal or transfer of shares in a company would not be subject to PNG taxation unless the Internal Revenue Commission of PNG deemed that a PNG resident shareholder had acquired the shares as part of a profit making scheme (i.e,. is in the business of buying and selling shares in companies). To the extent that PNG resident shareholders of InterOil did not acquire their shares as part of a profit making scheme (i.e., on revenue account) any gains derived from the proposed transfer of shares would not be taxable in PNG.