January 28, 2020
The unrelenting drive to increase government revenue is apparent from the various measures being adopted by the Federal Government. One of such measures is the Finance Act, 2019, which amended several provisions in the Nigerian tax laws, including the Value Added Tax (VAT) Act.
Many practitioners have applauded a number of amendments to the VAT Act, especially those focused at providing reliefs to taxpayers in some sectors of the economy. However, the amendments may have further compounded the woes of companies in the oil and gas sector, especially when evaluated vis-à-vis the recent amendments to the Deep Offshore and Inland Basin Production Sharing Contracts (DOIBPSC) Act, which increased the royalty rates payable by affected oil and gas companies. This is in addition to the amendment of the Petroleum Profits Tax Act in which the previous tax exemption enjoyed on dividends distributed from petroleum profits has now been withdrawn.
This article examines how some of the amendments to the VAT Act may affect taxpayers operating in the oil and gas industry.
Potential impacts on divestment of oil assets
Over the last decade, a number of international oil companies (IOCs) operating in Nigeria divested some of their onshore and shallow water projects in an attempt to rebalance their portfolio of oil assets. These divestments have resulted in the achievement of some of the objectives of the government’s local content policy in the upstream sector, as Nigerian companies own the majority of the oil blocks sold by the IOCs.
However, there are a couple of pending divestment transactions which are being delayed by litigations and regulatory approvals. It thus appears that the proviso in the VAT portion of the Finance Act, 2019 which expands the definition of taxable goods to include incorporeal properties such as interests in oil concessions may further discourage divestment activities, thereby hampering the government’s local content efforts. Although it may be possible to avoid the imposition of VAT on divestment of oil assets where the divestment options are structured differently, it is unlikely that affected companies will explore the alternative options.
Prior to the amendments introduced by the Finance Act, the VAT Act did not include a specific definition of “goods”. As such, the definition of goods to which VAT applied was limited to tangible goods while incorporeal properties such as interests in oil concessions were treated as non- VATable by taxpayers on the basis that they could neither be considered goods nor services.
This practice was further corroborated by a Federal High Court (FHC) ruling in the case between CNOOC Exploration and Production Nigeria Limited and the Federal Inland Revenue Service & Others, where the FHC held that the contractor rights in a Production Sharing Contract do not constitute either “goods” or “services” as contemplated by the VAT Act. Consequently, the FHC ruled that the assignment of the rights was not covered by the VAT Act.
In a bid to eliminate the ambiguity associated with the definition, the Finance Act, 2019 has now expanded the definition of goods to include any property over which a person has ownership or rights, or from which he derives benefits, and which can be transferred from one person to another excluding interest in land. Thus, the sale of interests in oil concessions will now attract VAT at 7.5%. This amendment will potentially increase the transaction costs for divestment transactions and the impact will be largely felt by local companies that may already be struggling to raise funds for the acquisition of the assets.
Increment of VAT rate from 5% to 7.5%
One major highlight of the Finance Act is the 50% increase in the VAT rate from 5% to 7.5%. We examine below, some of the implications of the increment in VAT rate on 2 different categories of oil servicing companies:
Oil servicing companies with recoverable VAT
Certain oil servicing companies currently incur recoverable input VAT on their cost of sales, as they import or manufacture goods such as drilling fluids, pipes and chemicals for resale to upstream companies. However, they are unable to offset the input VAT incurred against the output VAT charged because of the requirement for companies operating in the oil and gas sector to deduct VAT at source on vendor invoices. This requirement to deduct VAT at source was reiterated in the Finance Act. Thus, such companies continue to remain in a perpetual VAT refund position.