Monday, Octoberr 22, 2018/04:30PM/Deliotte
Exploration and production (E&P) companies often encounter challenges with the Tax Authority on tax deductibility of gas flaring expenses incurred in the process of their oil and gas production activities. The deductibility of gas flaring expenses has been controversial, although the controversy around its deductibility is not out of place.
Gas flaring entails burning off natural gas associated with production of crude oil and it has innumerable adverse effects, ranging from environmental to health impact including climate change, acid rain, pollution and haematological risks. Its negative economic effects cannot also be overemphasised as potentially valuable source of energy and revenue is wasted on a regular basis.
Nigeria is 6th in the global gas flaring ranking, with about 800 million standard cubic feet (MMSCF) of gas flared daily based on the World Bank Global Gas Flaring Reduction Partnership Report, 2017. This may suggest that the issue of gas flaring in Nigeria should be approached differently from an economic development perspective if countries like UAE and Vietnam that consume more significant volume of gas domestically are ahead of Nigeria in the World Bank ranking.
Aside other economic factors like regulated pricing, the capital intensive nature of infrastructure required for harnessing gas is the main bane for E&P companies, thereby making gas flaring the easiest and most rampant practice due to its affordability.
In its bid to address the environmental challenges associated with gas flaring, the Federal Government (FG) enacted the Associated Gas Re-injection Act (AGRA). The provision of AGRA directed E&P companies to stop flaring of associated gas (AG) produced in the course of their oil production activities. Instead of flaring the AG, AGRA mandates E&P companies to either find valuable alternative uses or re-inject it into oil production. Flaring is only allowed in certain circumstances as may be decided by the Minister of Petroleum Resources (The Minister) who may issue a certificate in that respect (Section 3(1) – (2a)) of AGRA.
Thus, a company can only flare gas after obtaining approval/certificate from the Minister. The Minister is also empowered to permit a company to continue to flare gas in the particular field or fields if the company pays such sum as the Minister may from time to time prescribe for every 28.317 Standard cubic metre (SCM) of gas flared (Section 3(2)(b) of AGRA).
In this regard, it is arguable that gas flaring charge paid by E&P companies, as determined by the Minister in the process of obtaining approval to flare gas, qualifies as a tax deductible expense because it was incurred for the purposes of their petroleum operations. This is in line with Section 10(1) of the Petroleum Profits Tax Act (PPTA), which provides that “there shall be deducted all outgoings and expenses wholly, exclusively and necessarily (WEN) incurred, whether within, or without Nigeria, during that period by such company for the purpose of those operations.
Furthermore, flaring charge is an example of the “other like charges” paid to governments as provided in section 10(1) (l) PPTA, which is considered deductible. Reinforcing the argument for deductibility, Section 11(2) (b) PPTA specifically recognises the payment of the charge as a condition for granting inherent incentives. Also, PPTA did not provide for flaring charge under Section 13 – Deduction not allowed for PPTA purposes.
Furthermore, Flaring charge is an example of the “other like changes” paid to governments as provided in section (10) 1 (1) PPTA, which is considered deductible. Reinforcing the argument for deductibility, Section 11 (2) (b) of PPTA specifically recongnizes the payment of the change as a condition for granting inherent incentives. Also, PPTA did not provide for flaring change under section 13-Deduction not allowed for PPTA purposes.
These arguments, amongst others formed the bases of the tax Appeal Tribunal (TAT) ruling in Mobil vs FIRS case. Furthermore, the TAT ruled that the actual Certification was not mandatory for tax deductibility purposes.
However Federal High Court (FHC) subsequently overturned this ruling in favour of FIRS. We are not aware that Mobil has lodged any appeal against FHC’s decision. This is on the premise of FIRS view which deems the flaring change as a penalty and does not agree that it qualifies as “WEN” expense incurred for the purpose of the business of the company in line with section 10 (1) of PPTA.
Therefore, flaring change, in FIRS’ opinion is a disallowable expense for tax purposes especially where the E &P
Company cannot provide the certificate issued by the minister to allow such company flare gas. This is premised on the strict interpretation of AGRA which required Ministerial approval/certificate as a precondition to gas flaring and underlying payment.
Although FIRS is empowered to use discretion in requesting relevant documentation that will enable it appropriately carry out tax assessment, deeming the flaring charge as penalty and concluding that it fails the “WEN” test, is not supported by both the PPTA and AGRA. This is more so as, practically, the flaring charge would have been paid prior to formal ministerial approval.
Taxpayers should not suffer for the procedural glitch, taking into consideration the copious provision s of the PPTA that support deductibility of flaring charges. Moreover Section 3 (2b) of AGRA directs that the payment be subject to the same procedure as for payment of royalty to Federal Government and royalty is a tax allowable expense.
FIRS demand for flaring certificate may, arguably, not carry weight as its issuance by the minister is optional going by the word “May” used in Section 3(2) of AGRA which states that “where the Minister is satisfied after 1 January, 1984 that utilization or re-injection of the proceed gas is not appropriate or feasible in a particular field or fields, he may issue a certificate in that respect to a company engaged in the production of Oil or Gas”. Conversely the use of “May” in this instance could be interpreted to relate to the “approval” and not just the formal certification which increases the controversy.
The above notwithstanding an inescapable inference is that the ambiguity in extant provisions has fuelled the above controversy. We hoped proposed legislative reforms can assists to lay this issue (tax deductibility of flaring charges) to rest.
The Nigerian Flare Gas (Prevention of Waste and Pollution) Regulations 2018