However it has been suggested that the fiscal requirements placed on companies by the bill in its current forms are too chaotic, and will discourage new investments in Nigerian Oil fields, especially in areas that require high investments- such as the deep offshore fields[2]. In other words, it is believed that the current provisions of the bill are not neutral in fiscal terms.
It is my objective to examine the fiscal provisions of the PIB with respect to its predecessor in order to determine the effectiveness of its recommendations in terms of its fiscal regime. This will be done by looking at the key natural resources taxation concepts of Government take, Economic rent, Efficiency and Neutrality, Incremental Investment and Stability. I will kick off with the examination criteria mentioned above and will consider Economic rent, Efficiency and Neutrality together as these concepts are closely linked and equally important.
Finally, in this article, I will examine the current fiscal regime in Nigeria and its key provisions. These will serve as a precursor to an in-depth analysis of PIB and its key revisions from the PPT in my next article.
Core Concepts in Resource TaxationIt is necessary to start by introducing some of the tools used in comparing and analysing the two tax regimes; key concepts such as government take, economic rent, efficiency and neutrality, opportunity for incremental investment and stability. These provide basic framework for assessing the necessary criteria and in determining the effectiveness of a fiscal regime as used in this analysis.
Government Take
This is a major consideration for assessing the viability of a resource taxation system by Investors. It is the amount that the investor pays for exploitation of the resources through all forms of taxation and levies including royalties, bonuses, income taxes and other fees. This also includes obligations such as local content obligations or environmental requirements and charges. It is the cumulative transfer of wealth to the government and is affected by all tax allowances. In effect it can make or break a fiscal regime, and in turn the level of favourable investment that would take place because companies use this as a measure of comparing expected returns from projects between different countries[3] and has to provide the investor significantly greater returns than other investments in compensation for perceived political and/or commercial risk[4].
The concept of Government take encompasses that of equity which denotes the presence of fair distribution of the profits from mineral resources between the government and the company. In its definition is the issue of timing of government take. If levies are front end loaded, they would have a negative impact on NPV (Net Present Value), being required nearer times and affecting time value of money. On the other hand back end loaded regimes undercut government revenue. Perfectly equitable timing would allow suitable cost recovery by investors before government tax resumption.
Economic Rent, Efficiency and Neutrality
In petroleum taxation economic rent denotes the additional or supernatural profit obtained by investors due to the scarcity derived from exhaustible hydrocarbon resources[5]. This profit denotes additional revenue net exploration, development, operating costs and the minimum rate of return demanded by the company as defined by its discount rate[6]. In calculating rent, costs relating to market price, technology and variation in geology as well as company discount rates need to be known and predictable. However, seeing as these are impossible to predict, and company discount rates are usually undisclosed, economic rent cannot be determined realistically. For government not to distort investor production decisions, it is necessary for fiscal instruments to target economic rent. For this purpose, the maximum tax that would not influence investor production decisions is the ideal level that taxes economic rent. This level would be considered as an efficient tax regime.
In explaining efficiency, companies’ desire to maximize profits and their consequent consideration of tax magnitude as included costs must be considered in providing regimes that are not too high. However an overly generous regime would lead to overexploitation and revenue loss. Therefore efficiency denotes that level of taxation that is neither too high nor too low and would not discourage investment, or encourage overinvestment[7]. This is in turn defined as a neutral tax regime, and by definition, efficiency equals neutrality. From the government point of view, perfect neutrality connotes tax revenue received only when the company is profitable and no income during periods of negative profits. A brown tax would be a neutral regime.
The obvious attraction is that a company would only pay taxes on surplus profits after operating, development and exploration costs have been deducted and there is a reasonable profit retained for reinvestment i.e. economic rent is taxed. Therefore in order to ensure neutrality, taxes should be set relative to given thresholds based on the NPV.
Incremental Investment
All the points listed above affect the possibility of incremental investment which denotes likelihood of a fiscal regime encouraging reinvestment in the petroleum sector. Investors would usually look at long term operations in countries and so would consider the viability of increasing investments. Sudden Increase in the fiscal costs could affect the likelihood of further investments in the country by reducing attractiveness for prolonged/ additional investments. Incremental Investment opportunities would attract new investors and retain existing ones.Stability
Investment decisions are made using calculations of expected cash flows which factor in existing tax systems as costs along with required discount rates. If there is not a reasonable degree of predictability, distortions and uncertainty would discourage proper calculation of these figures, or increase their values. The investor considers two criteria for stability; government stability, and the fiscal regime flexibility. It is important to the investor how politically stable the country is with higher instability increasing applicable discount rates. This can be mitigated investors insisting on stabilisation clauses in the legislation or production contracts. However the extent of reliability is debatable, meaning that instability still is of considerable importance.
The flexibility of the Fiscal Regime on the other hand denotes the ability of the regime to adapt to changing economic circumstances. The regime needs to be adjustable to the price cycle of the petroleum industry, allowing for responsiveness to fall in prices, and unforeseen cost increase involving technical, economic or social shocks.
Current Nigerian Petroleum Fiscal System
I will now introduce the main provisions of the PPT whilst highlighting the areas of tax, take and deductions to the investors. Let us recall that all this is provided as preparation for the final analysis.
Petroleum Profit Tax
The principal legislation governing petroleum operations in Nigeria is the Petroleum Profits Tax Act (PPTA) 2007, its main fiscal instrument being the Petroleum Profit Tax (PPT), a resource rent tax which focuses on profitability. This tax is considered progressive as it taxes only increases in profitability, with an NPV threshold rate calculation. Under the PPT the tax rate is set at 67.5% for the first five years of taxable operation by the company, and 85% thereafter.
With regards to allowances, the PPT provides for capital expenses including intangible drilling expenses, exploration expenses, and expenses for appraisals of the first two wells dug, and losses brought forward indefinitely. Further deductions are provided via an annual allowance at the rate of 20% for the first four years and 19% for the fifth year on all qualifying capital expenditure. Additionally there is a PIA (Petroleum Investment Allowance) set at 5% for onshore operations, 20% on offshore debts above 200m and up to 50% on deep offshore PSC (Production Sharing Contract). Although all tax allowances are deductible on income, tax offsets are not allowed to reduce the companies’ tax rate below 15% throughout the entire project life[8] including periods of no profit. The main structures of fiscal regimes used are joint venture contracts (JVC), Production sharing agreements (PSA), and to a lesser extent the Sole Risk Independent Operators[9].Production Sharing Agreements
The Nigerian PSC is a contract between the NNPC (Nigerian National Petroleum Corporation) and one or more private contractors. Here the NNPC functions as the sole licence holder of the concession while the contractor bears all the risk. The PPT rate for this system is 50% of profits, contractors entitled to PIA at 50% of investment[10].
A non refundable Signature Bonus is paid on the OPL (Oil Prospecting Lease). The rental fee for this OPL is $10/km, with any arising OML (Oil Mining Lease) having a rental fee of $20/km for the first ten years and $15/km afterwards[11]. There exists a sliding scale royalty which varies based on the area of the concession and water depth with production costs not deductable for the purpose of their calculation. These are as high as 18.5% at the least cost inland basins[12]. From total lifting, royalty oil is allocated to the NNPC, cost oil to the contractor and tax oil to the FIRS (Federal Inland Revenue Service). Profit oil is split between the NNPC and the contractor.
Joint Venture Contracts
The JVC (Joint Venture Contract) is a contract between NNPC and one or more oil companies in which all members are joint concessionaries of the oil blocks, and it (JVC) is governed by a JOA as its binding contract. An IOC acting partner serves as the operator of the project, while the other partners make monthly cash calls as their investments, payable on the basis of equity participation. Each partner is subject to royalty and tax on its production share. Here the partners are exempt from corporate income tax, but liable to PPT. The investors are also obliged to contribute 2% of annual profit to the Education Trust Fund (ETF) and 3% to the Petroleum Development Trust Fund (PTDF)[13]. They also contribute 1% of annual payroll and 5% of each employee’s basic salary towards the Industrial Training Fund (ITF), and VAT on goods and services excepting exports. The companies are obliged to pay taxes applicable to the different tiers of government including the local, state and federal government taxes[14]. No domestic supply obligations exist and dividends are exempt from withholding tax.NUTSHELL:
In this article, Opeoluwa builds up the case for a comparison of the PPT and PIB legislations by establishing the foundation of his anaylsis on the core concepts of resource taxation. He goes on to give a background of the existing fiscal practice of the Nigerian government . This will set the tone for an examination of the overall competitiveness and fiscal design issues of the Petroleum Industry Bill and its provisions in his next article. To view Opeoluwa's professional profile and for more information on this article please click here: -->
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