In "The Wealth of Nations" (1776), Adams Smith set forth four maxims, or canons, of taxation. These four maxims have been summarised in four words: Equity, Certainty, Convenience and Efficiency. When Adams Smith postulated these canons perhaps he did not envisage the complexities of business arrangements in today’s world. Otherwise he would not have added certainty and convenience to his list.
According to Adams Smith, “The tax which each individual is bound to pay ought to be certain, and not arbitrary. The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor, and to every other person”. In Nigeria, we have inherited our laws and tax statutes from our colonial masters. While the rest of the commonwealth and the UK, our colonial masters, have moved to clarify their laws and update them in line with modern realities, we have continued with these archaic laws. And where we bothered to review these laws, we have done so in manners that indicate that clearly, the sponsors of these reviews and those who are saddled with effecting the reviews do not consult the relevant professionals and practitioners who are knowledgeable enough to know where and what should be amended. More importantly, we ignore the opinions of the tax payers and appear to completely forget the famous adage “no one knows where the shoe pinches like the wearer.”
These are not empty assertions. I will give two scenarios from our recently amended VAT Act. The latest amendment was in 2007. Section 8 (1) (on registration) states that “A taxable person shall, within six months of the commencement of this Act or within six months of the commencement of business , whichever is earlier, register with the Board for the purpose of the tax.” My layman’s understanding of this sentence is that since the Act was enacted in December 1993 and commenced in 1994, every business is required to be registered for VAT by June 1994 at the latest! This indicates that a company incorporated today is already in breach of this law! This particular provision is still in the Act after several amendments.
The second scenario I will like to mention from our VAT Act is the provision under the caption “remission of tax collected by Government Ministries.” Under a caption so titled, there is a provision that “the service shall by notice determine and direct companies operating in the oil and gas sector which shall deduct VAT at source and remit same to the service”(s10A (2)). The intention of this section is clearly to increase collection and minimise default. But in solving a problem another was created. There is no equivalent provision in any VAT Act in the world.
A Consumption Tax Now A Tax On Income
VAT, a consumption tax, has now been elevated to a tax on business by this provision and I will go on to demonstrate this. A business which exclusively supplies the oil & gas industry will perpetually generate output VAT that will be withheld by its customers. Thus effectively, it will never have output VAT against which it is supposed to offset its input VAT. So what happens? The input VAT is passed on as part of cost of sales. Yet it is not so simple. By forgoing a claim of input VAT for an income tax deduction, the company recovers only the tax rate on the input VAT. Our income tax rate is 30%. Whereas, by claiming input VAT the company would have offset the entire input tax. Thus the company now recovers only 30% as against recovering 100% if it had claimed input VAT. All this will inevitably affect cashflow and profitability.
Lest, I stray permanently from my subject, this piece is about the taxation of Oil & Gas. Why is the law on taxation of oil and gas in Nigeria so muddled up? Perhaps it is only seemingly so to the uninitiated but I beg to differ. Perhaps we should return to the over 200 year old words of Adams Smith again; “the tax which each individual is bound to pay ought to be certain...” Collectively, the Oil & Gas multinationals in Nigeria spend $10-20 million paying for tax advice every year. This is a conservative estimate. In truth they can seek the opinion of more than 3-4 “experts” on a particular tax issue and each will give conflicting and varying opinion. Why is this so? Is the knowledge of taxation of Oil & Gas in Nigeria so mysterious? The Dictionary tells me a mystery is something that baffles understanding and cannot be explained. If this definition is correct, then the taxation of oil and gas in Nigeria is certainly not mysterious. It may baffle the understanding of some but it can be explained. Yes, explained within the ambit of existing laws on the taxation of oil & gas and harmonising the positions of “experts” and perhaps kowtowing to the opinion of the Revenue Authority in order to avoid a conflict!
There are different taxation regimes in the oil and gas industry depending on the fiscal regime a company engaged in petroleum operations is in. Indeed the term “engaged in petroleum operations” have varying interpretations among experts. For the purpose of this piece, we would adopt the term “engaged in petroleum operations” to mean any one required to pay petroleum profit tax.
The tax rate is largely dependent on the contractual arrangement employed by the tax payer. The existing contractual arrangements include Joint Venture Agreement, Production Sharing Contract, and Risk Service Contract. There are variants of these contractual arrangements. The names of these contractual arrangements describe the nature of the arrangements. The JVs are essentially NNPC and the multinational oil companies entering into business for the purpose of sharing oil find.
Here cost and profits are shared in the agreed ratio. It is for the JVs that the NNPC requires its cash calls and they are the focus of much of the reforms in the proposed petroleum Industry Bill. A JV operating for more than 5 years is taxed at 85%. One in its first 5 years is taxed at 65.75%. Its tax adjusted profits are further adjusted by the terms of the memorandum of understanding (MOU) reached between the Federal Government of Nigeria and oil producing companies in JV operations with NNPC. The first of these was signed in 1986. The main objective of the MOU is to guarantee the E & P companies a profit margin, irrespective of the market conditions. The margin was determined by a combination of formula used to arrive at an incentive, known as the “MOU tax credit.”
The PSCs involve the NNPC contracting with a company designated “the Contractor.” The Contractor would engage in Exploration & Production (E&P) activities, but it has no title to the crude oil produced from there. The contractor will recover its costs from the discovery of oil in commercial quantities from the allocated block. Thus the Contractor bears all risks but not all the reward!
The terms of most production sharing are largely similar. Yet disputes have been reported between the NNPC, Federal Inland Revenue Service (FIRS) and the contractors on the interpretation of certain provisions relating to amongst others, royalty computation, cost recovery and computation/payment of Petroleum Profit Tax (PPT), Investment Tax Credit etc.
It appears that there are scenarios such as cost consolidation (of different contract areas held by a contractor) that seems to disagree with the provisions of the Petroleum Profit Tax Act (PPTA) and the Deep Offshore (Production Sharing) Act (DOA). Who between the NNPC (who has legal rights to the fixed assets employed) and the Contractors (who purchase these fixed assets and actually use them in their operations) should get the tax deduction (capital allowances) and Credits (investment Tax Credit) etc among the parties. These questions are yet to be answered satisfactorily by “experts” and there are more posed in the new PIB. Space will not allow me do justice to all these questions but it is time regulators, professionals and business men begin talking to each other more seriously before enacting or reviewing our tax laws.
Eben Akinyemi, an Associate of the Institute of Chartered Accountants of Nigeria and the Chartered Institute of Taxation of Nigeria, is a Partner at the transactions advisory firm Stransact Partners.